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Rigidity of mortgage contracts and a variety of frictions in design of the market and the intermediation sector hindered efforts to restructure or refinance household debt in the aftermath of the crisis. Using a simple framework that builds on mortgage design literature, we illustrate that automatically indexed mortgage contracts or debt relief policies can reduce borrower’s debt burden during economic downturns, thereby leading to significant welfare gains. We show that benefits of such solutions are substantially reduced if there are errors in understanding the underlying structure of income and housing risk and their relation to the indices on which such contracts or policies are based. Empirical evidence reveals significant spatial heterogeneity and time-varying nature of the distribution of economic conditions. This, ex-ante, poses challenges to effective design of automatically indexed mortgage contracts and debt relief policies. We also discuss significant spatial heterogeneity of frictions that can differentially impact pass through of ex-post debt relief policies implemented by financial intermediaries. We conclude by discussing potential gains from indexing mortgage contract terms or debt relief policies to local economic conditions as well as other mechanisms that minimize adverse effects of various implementation frictions.

Piskorski, Tomasz, and Amit Seru. 2018. “Mortgage market design: Lessons from the Great Recession.” BPEA Conference Draft, Spring.

The authors received financial support for this work from the National Science Foundation under grant no. 1628895. With the exception of the aforementioned, the authors did not receive financial support from any firm or person for this paper or from any firm or person with a financial or political interest in this paper. They are currently not officers, directors, or board members of any organization with an interest in this paper. No outside party had the right to review this paper before circulation.