Want to Cut Your Debt? Work Less.

Casey B. Mulligan is an economist at the University of Chicago.

Update | 11:17 a.m.



However, housing prices have fallen dramatically since 2006. By 2008, about 12 million mortgages are “under water” — meaning that the market value of the house had fallen below the amount owed on the mortgage. Because of the low resale values, foreclosing on any of the homes will not yield lenders their entire principal; lenders in those cases must rely on the good behavior of the borrowers.

Officials at the Federal Reserve, the United States Treasury, the F.D.I.C., Fannie Mae (most recently, its “Early Workout” program) and Freddie Mac have encouraged lenders in such cases to “modify” mortgages — that is, to accept a stream of payments from the borrowers that is different from the amounts promised when the mortgages were initially signed. In particular, these “modification programs” encourage lenders to reduce mortgage payments so that each borrower’s housing payments (including principal, interest, taxes and insurance) are 38 percent of the borrower’s gross income. The payments are to be reduced for five years, or when the mortgage is paid off (whichever comes first).

Of course, a borrower cannot be harmed by the opportunity to have a mortgage payment reduced. But what is economically noteworthy is that the amount of the payment reduction depends on the borrower’s income — the less he or she earns, the more the payment is reduced. For example, a borrower whose annual family income is $100,000 can get housing payments reduced to $38,000 a year, whereas a borrower whose annual income is $50,000 can have the payments cut to $19,000 a year.

One implication of the mortgage modification rules is that a family that earns $50,000 less in the year before the modification stands to save $19,000 a year for five years on housing payments — for a total of $95,000. And once the mortgage has already been modified, the family is free to earn as much as it wants without further affecting its payment rates. That makes 95,000 reasons to hesitate when looking for a new job, when wrapping up a maternity or paternity leave, or when confronting other job transition situations.

I do not expect every adult among those in the 12 million underwater households to be without a job because of the modification rules. Although modification professionals have specialized in educating homeowners about their modification options, many homeowners probably do not fully understand the mortgage consequences of their earning decisions. Nobody knows the exact numbers, but, even if 90 percent of homeowners were oblivious or uninterested in their modification options, that would leave over a million households that were aware. One million-plus workers would make a large dent in the employment statistics.

My previous post reminded readers that productivity has been rising and employment falling in this recession. If approximately one million workers realized that earning income in 2008 was not in their financial interest — and acted on this realization — their actions would significantly reduce aggregate employment and hours. And if businesses operated with less labor, labor productivity would rise. Maybe the housing crash and mortgage modification programs that followed have something to do with the recession of 2008.

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From the ivory towers, it apparently makes sense to theorize that unemployment is increasing because people don’t want to work.

The author should reconsider his faith in these formulas. Perhaps he is unfamiliar with factory work, has never been laid off himself, or has never personally had the experience of needing to lay off a friend or a colleague.

When a formula leads to a counter-intuitive conclusion (and the conclusion is counter-intuitive to anybody with experience working for a living), then the connection between mathematical abstraction and the ability of the math to describe something in the world should be considered.

In this case, it is claimed that the math informs that there is less employment because people do not want to work.

Since the conclusion is about a psychological state, it would be (pretty) easy to test the hypothesis suggested by the math with field interviews. You could ask people who recently quit working, if they want to work or not and how it is affecting them. If it turns out that almost everybody who was laid off did not want to be laid off and finds it problematic to lose their income, then the interpretation of the math will have to reconsidered. Maybe productivity is rising because employers require more of the remaining workers. That might well be the case.

It’s preposterous to suggest that people will prefer to scheme and work less for a favorable deal on their mortgage, and won’t care about the resulting financial struggle. The mortgage isn’t the only expense involved in keeping a household afloat, especially when there are children to support.

This piece must have been written by someone with an inability to connect with the concept of living through the consequences of financial hardship, as it is breathtaking in its ignorance.

The reasoning in this argument is seriously flawed. and perhaps indicative of the ideological or political prejudices of the author.

There are other things one can do with money aside from make mortgage payments. Although the family with a $50k income is “saving” money with respect to the $100k family through the mortgage modification program, do I really have to point out that they are also “losing” money by not earning more?

Would any sane person actually decide to earn less in order to pay less on a mortgage? Does anyone take seriously the contention that someone will actually decide to go without a job in order to avoid mortgage payments? The premise is silly, making the conclusions every bit as ridiculous as they sound. This is no serious argument — it is nothing but political.

Besides, I think the cousin of this argument with regards to tax policy (“supply-side economics”) has been soundly debunked, more than once. And I highly doubt that the author will apply the same logic to the bailout of Wall Street, which of course is an actual reward for bad behavior, bound to have real economic consequences unless we step in and impose real regulation.


Yes, that means that the former person is making $62,000/yr and the latter $31,000/yr after mortgage payments. Now, would you rather make $62,000/yr or $31,000/yr, Mr. Mulligan?

I thought so. So I guess it turns out that costs that are a fixed percent of income do not affect the incentive to earn more after all. Quite the opposite: the less disposable income you have the more incentive you have to work more, either to find a higher paying job for your skillset or to work a second job. The problem is that if mortgage payments are, say, 80% or 130% of income, then nobody is going to be able to pay and you will have more foreclosures, which is not good for anybody.

What you seem to gloss over is that such programs are beneficial to the lender as well as the borrower. At this point there is no way the lender is going to make any money off the original investment; their only reason to keep the original terms for now is to avoid marking a loss in their books for as long as possible. But when push finally comes to shove and they have to forclose, they are absolutely going to lose money right now. Now if they are able to bring in a reduced stream of mortgage payments for the duration of this recession and then perhaps increase the rates again once people are back on their feet, they stand to lose much less money or even gain a little if housing prices start rising a bit.

“… stands to save $19,000 a year for five years on housing payments — for a total of $95,000.”

…but they also are earning $50k/yr less. So over 5 years they lose $250k in income to gain $95k on lowered mortgage payments.

Where do I sign up???

As long as the principal amount of the mortgage is not decreased, I’m all for keeping people in their homes. Might the realization that it will take significantly longer to pay off the mortgage encourage people to either increase their earnings or to sell for a more affordable house when the market becomes favorable? The professionals involved in underwriting and purchasing subprime mortgages are the ones to blame for the crisis as they had the power to just say no to obviously bad loans but were too greedy to do so.

We bought a house we could afford at a decent price in a great neighborhood four years ago. 30 year fixed @ 7%. Then a year later, our city “reassessed” our house and jacked up it’s “worth”.

Now we’ve tried to refinance to take advantage of the lower interest rates and save some money each month. But surprise! According to the bank, we’re “underwater” and we were declined. That’s nice. So you do everything right, work your a@@ off, try to save a little money, and you get screwed. Meanwhile, all the people who broke the law and made bad decisions get bailouts and refinancing options.

Homeowners should have banded together and sued the cities that tried to reassess them a few years ago. If the city had left us alone, we could have refinanced and that money would have gone right back into the economy. Idiots…

I am confident that what you were thinking when you were writing the last sentence of your post was somewhat different from what you wrote. You wrote, “Maybe the housing crash and mortgage modification programs that followed have something to do with the recession of 2008.” However, what you were thinking was something like, “Although the housing crash clearly has a lot to do with the recession of 2008, maybe the mortgage modification programs that followed have had something to with it as well.”

Ah, coming full circle — through the Arctic circle, but still. Let me get this straight. In your first post you said that the current recession is, in part, caused by people choosing to work less. That’s already a stretch, but fine, I give you that.

Now you say that based on the mortgage bailout, people would be encouraged to work fewer hours. Again, some problems with that — e.g. it doesn’t matter that someone making $50k pays less in mortgage compared to someone making $100k; what matters is total income, and that’s still higher for the person making $100k, let alone that the job would be more satisfying, more desirable, etc. — but sure, I give you that one too. (It’s the holidays.)

Now, how do you explain unemployment rising all through 2008 because of the mortgage bailout passed in late 2008?!? Perfect foresight by millions of Americans who anticipated the economic collapse and the government’s answer to it?

Tough to think how you could have put your foot in your mouth more so than in your first post, but you did it again. Congrats, prof!

1. I know economists assume all sorts of things, but how did you get the idea that a family earning $50K will save $19K?

2. If I earn $100K/yr and pay $38K/yr, my adjusted gross income would be $62K. If I earn $50K/yr and pay $19K/yr, my adjusted gross income would be $31K. Where is the incentive for me to downsize? I don’t see the logic. I guess this makes me a bad American, or perhaps a bad condidate for a University of Chicago PhD in economics.

The concept that “earning income in 2008 was not in their financial interest ” when adding 1 dollar of income results in a 38 cent increase in a modified mortgage payment is dubious because:

1) Increased mortgages payments lower the total mortgage amount.

2) There is a benefit from the other 62 cents of income which probably outweighs the effect of the 38 cents.

3) The tax consequences at lower incomes levels are minimal, but include a tax benefit from higher mortgage interest paid.

To consider seriously the last statement:

you would need a better estimate of how many mortgage modifications occurred in 2008 than 10% of all underwater mortgages. And then you would to explain away points 1 and 2.

From what I have heard, the actual number of mortgage modifications has been small so far. But I would be interested in actual statistics.


Mortgage Modification Meltdown
The bailout program still isn’t reaching homeowners
By Broderick Perkins

If you work the full calculation, simplifying the tax rates which skew the argument in favor of not working, you cannot reach the same conclusions. With an income of $100,000 per year, a family will have $62,000 available after paying the mortgage. Assuming 28% tax rate on the $62,000 gives them roughly $44,000 to live. A family making $50,000 per year will have $31,000 available, which, assuming a 15% tax rate gives them about $26,000. After 5 years the family with the larger income has $25,000 more discretionary income and $95,000 less debt.

Why not then change the program so that people who have negative equity have their principle reduced. That way they could regain equity but have no disisentive to seek greater income or allow their home to go into foreclosure. The amount of principle reduction for each mortgage would be proportional to the percentage fall in value of the associated property.

I don’t follow your logic. Both mortgage payments AND take-home pay after mortgage payments would increase. (62% of $55,000 is greater than 62% of $50,000). By “working harder” as you put it, you would have more money in your pocket AND pay your mortgage down faster.

You write: “One implication of the mortgage modification rules is that a family that earns $50,000 in the year before the modification stands to save $19,000 a year for five years on housing payments.” Surely, you must mean compared to someone with the same mortgage payments who earned $100k the year before the modification… Otherwise the whole exercise makes no sense. If the comparison was to the very same loan before modification, the savings might be much more or much less than $19k/year. When you properly identify the comparison class (i.e., those people with similar mortgages but who earn twice as much) it becomes clear that the perverse incentive you identify is potentially a much smaller factor than you make it out to be. After all, how many people are in the position to opt not to take a job that doubles their current salary for the sake of lower mortgage payments?

Moreover, those whose salaries double to $100k–while losing mortage mod savings of $19k/year–end up with a gain of $31k/year. We would need to balance this against the incentive to stay in lower paying work.

As for those who opt not to work–which seems to be what you’re concerned about in the last sentence of the second to last paragraph–they’re going to lose their homes anyway. The mod plans make the decision on whether to modify contingent on the values of the loan as modified and of the home as foreclosed upon. the value of a loan to an unemployed borrower approaches zero, so no modifications will be extended to such a person. If the borrower is simply underemployed, it is likely that they won’t get the modification. Again, the perverse incentive is not what you identify.

There is no question that the modification plans may create perverse incentives in some borrowers, including an incentive to default so as to be able to take advantage of the existence of such plans. Some of these can be dealt with, some can’t. But it is important to properly identify what the incentives really are. It is also important to weigh them against the potential upside of making the mods.

thanks for a stimulating column.

All these comments calculating that you make more by working more and paying the mortgage are missing the point. The difference is that you have to work. Unless your time has no value to you other than the wage your can earn with it, you need to consider those other options.

This is basically an income tax. Take an extreme example of a 99% tax rate on a household’s second worker. It’s true that the household would earn more income if the second member worked a job making $100k/year. But don’t you think you could find a better way to spend 40hour/week for a year than pulling down a cool grand?

I think the author is concerned about people intentionally getting into a low-paying job first, then negotiate for reduction in loan payment which would be held fixed for 5 years, and then change to a high-paying job once the deal is done. The main point is the reduced payment is held for 5 years:


So on the basis that the household has the ability to generate $100k income annually and actually chooses a $50k income job initially and then switches back to $100k income job quickly, the author’s example does seem to work out in allowing the household to keep more cash on hand.

Of course, not everyone who knows this trick could easily find a $100k job since many factors are involved. The job market isn’t really that re-assuring for a start. The negotiations might also turn for the worse since the banks hold the final say.

So on what is more practically possible, I tend to agree with all the comments posted.

The conclusion that “…earning income in 2008 was not in their financial interest” is difficult to justify in the example, but not overly difficult with a different set of assumptions. Assume the choice is between earning $50k and $75k, by choosing to return from maternity/paternity leave, or other job transition choices. The $25k in additional gross income is offset by a ‘loss’ of $9,500 in mortgage payment savings and higher income taxes of $3,750 (assuming the same tax bracket), leaving about $11,750 in additional income. Now that’s not an insignificant amount, but it’s easier to see how the choice might be more difficult.

This scenario might make some sense in a family with two workers each making $50K a year. If one loses a job, then the family would be better off having that person wait to find a new job until after negotiating a loan modification. It is not clear whether the loan changes are changes to the rate of paying down principal or reductions in interest rates. In the latter case, then the family could have some advantage.

Of course the family that chooses unemployment, with the loss of $50,000 in income, will be able to make up most of the difference out of its vast savings and will meet with no short run consumption constraints.

And of course the family will not apply the appropriate discount rate to the $95,000 savings over the next five years and consider their net present value.

That would be $50,000 lost now balanced by something less than $95,000 gained, because the gains come over 5 years time and the family will forego interest or other investment income.

Please rewrite and resubmit this problem set Mr. Mulligan.

I would also suggest that you deal with the common observation that the physical productivity of labor is counter-cyclical. When the econmy is in a boom the physical product of labor falls. When it slumps it rises.

You should also make it clear that you understand that the demand for labor depends on the marginal value product of labor – that would be price of the next unit of output multiplied by the marginal physical product of labor.

How did you get your job anyway?

Bravo! This is a wonderful parody of the “assumptions” and “models” of the reality-challenged, math-savant economist! I’m surprised nobody else seems to get the joke.

If the faux ivory towers that economists occupy (real academics won’t let them into genuine ivory towers) are underwater, it would be no surprise. Given economists’ powers of analysis and forecasting—demonstrated with such aplomb throughout the current crisis, and nowhere more clearly than in Mr. Mulligan’s piece, above—it is likely that they refinanced their towers at the very worst time, at the very worst rate, and on the very worst terms.

The problem is that economists such as Mr. Mulligan believe that human beings are perfectly rational agents who are motivated only by money. This is so evidently not the case that it defies belief that anyone is sufficiently brazen still to wheel it out.

In reality, the woman who puts off returning to work after pregnancy leave will do so because she can’t bear to be parted from her baby. The manager offered a promotion will take it because he’s coveted the job (not just the salary) for years. We’ll all work more hours because we all feel less secure. Mortgage modification costs will play an infinitesimal role in such choices.

Only economists, alone but happy with their calculators, will base their life decisions on a continuing process of optimizing down to the cent their net earnings.

This is exactly whats wrong with our society! Every thing that is common sense is wrong. Everything less than correct is policy and/or law.

It would make sense that the banks ALSO renegotiate with homeowner’s that are paying on time and taking care of the house. Why? Because the bank doesn’t have to go through the hassle of foreclosure, maintenance, and selling a house at a loss. Yet the banks are pretty much giving people who can no longer afford a house the breaks.

A banker told me that basically the the homeowners that are paying on time are subsidizing those that are not and those that are in default.

I rue the day I bought a home in this place called America!

Does anyone even know someone who modified their mortgage? I know several attorneys (bankruptcy, real estate and divorce) who have tried but have yet to accomplish a single mod.

Why would banks ever entertain this option now that the Government has issued multi billion checks to them?

When the author was saying a household could stand to gain by earning less to qualify for a larger payment cut, I believe he was intending to emphasize a temporary earnings depression (which, in many cases, could be artificially induced by the household).

A savvy earner could drop his documented income to $50k, qualify for five years worth of lower payments, and then boost his income back up to its true level of $100k after his loan has been modified.

Not something that sounds like a good idea to me, but I wanted to clarify as I think some comments are assuming the comparison is between $50k income for five years vs. $100k income for five years.