We use variation in mortgage modifications to disentangle the impact of reducing long-term obligations with no change in short-term payments (“wealth”), and reducing short-term payments with approximately no change in long-term obligations (“liquidity”). Using regression discontinuity and difference-in-differences research designs with administrative data measuring default and consumption, we find that principal reductions that increase housing wealth without affecting liquidity have no effect, while maturity extensions that increase only liquidity have large effects. Our results suggest that liquidity drives borrower default and consumption decisions, and that distressed debt restructurings can be redesigned with substantial gains to borrowers, lenders, and taxpayers.

More on this topic

BFI Working Paper·Jun 18, 2025

Maturity Risks and Bank Runs

Jihene Arfaoui and Harald Uhlig
Topics: Fiscal Studies
BFI Working Paper·Jun 17, 2025

The Welfare Effect of Marginal and Nonmarginal Changes in Sales Taxes in the U.S.

Ingvil Gaarder and Lancelot Henry de Frahan
Topics: Economic Mobility & Poverty
BFI Working Paper·Jun 10, 2025

Global Price Shocks and International Monetary Coordination

Veronica Guerrieri, Guido Lorenzoni, and Iván Werning
Topics: Monetary Policy