Wednesday, November 19, 2008

UI on Steroids

Suppose that you bought a house in 2005, and took out a mortgage equal to four year's income. Now your house is worth three year's income.

More bad news: you lost your job, and your income is cut in half because unemployment insurance (UI) only replaces that much.

Your best course of action may be to FAIL to find a new job. First of all, you can continue UI as long as Congress extends it and you are still without a job. More important, Citi-group is your mortgage lender, and (hypothetically) they are especially willing to renegotiate mortgages with people who are unemployed. That is, by remaining unemployed you greatly enhance your chances of seeing one year's salary (on your previous job) taken off your mortgage.

I don't know how common is this situation. I do know that at least some mortgage lenders are considering employment status when restructuring a mortgage:
"[Citigroup] recently streamlined its loan modification program to rework delinquent loans. This revamped program uses a simplified formula to figure out an affordable payment as a percentage of the borrower's gross income. It then reduces the monthly payment to that amount by either reducing interest rates on the loan, extending the loan's term or forgiveness of principal." (from Mamundi 2008, emphasis added)
I am not aware of the percentage used by Citigroup, or the frequency over which it measures borrower's gross income for this purpose. For the sake of illustration, suppose that the percentage were 25. An action taken by a borrower to increase his income would increase his payment obligation by 25 percent of the income increment. If an affordable payment were reevaluated monthly, this would amount to a 25 percent marginal tax rate over the life of the loan. If, say, 2009 income were used to calculate an affordable payment for the years 2010-14 and the interest rate were 6 percent per year, then the marginal tax rate would be 108 percent for 2009 (4.3 times the percentage from the formula) and zero thereafter.

It is conceivable that mortgage restructuring could do significant damage to our labor market. Notice that this is an issue of settling past loans, not an issue with making new ones. I explain these results in more detail in a working paper (available from NBER or from This research is ongoing, so please check back here for updates, corrections, etc.

Also note that I HAVE CHANGED MY MIND about the damage that deflation could do in today's economy -- it could be a lot via this mechanism.

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