When Are Modifications of Securitized Loans Beneficial to Investors?

Loan modification is widely discussed as an alternative to foreclosure, but little research has focused on quantifying its effect on loan performance. I quantify this effect early in the housing crisis by exploiting exogenous variation in the incentives to modify securitized nonagency loans. An additional modification reduces loan losses by 35.8% relative to the average loss; this reduction suggests that the marginal benefit of modification likely exceeded the marginal cost. Consistent with the idea that high-income borrowers may be better equipped to withstand bad economic times, I find that modifications are especially beneficial when borrowers have larger loans. Received April 25, 2016; editorial decision March 24, 2017 by Editor Philip Strahan.