The Impact of Crisis-Period Interest Rate Declines on Distressed Borrowers

Abstract

We measure the causal impact of reductions in benchmark interest rates on the renegotiation and performance of distressed loans, using 2000s subprime adjustable-rate mortgages as a laboratory. Subprime borrowers treated with larger benchmark Libor rate declines benefited from increased debt-renegotiation and lower debt-service payments. The estimated effects are similar across both current borrowers and those in default. Renegotiation of mortgage debt also reduced foreclosures over the longer term. However, following debt-renegotiation, surviving treated borrowers re-entered and lingered in serious delinquency. Findings suggest that while policy may effect reductions in benchmark rates and spur debt-renegotiation, such interventions may not lead to longer-run curative outcomes.