The Imitation Game : How Encouraging Renegotiation Makes Good Borrowers Bad

We show that commercial mortgage borrowers behave opportunistically in order to obtain principal reductions. To guide our empirical analysis, we develop a model in which lenders cannot perfectly observe borrowers' use values and renegotiation is costly. We then study the effects of a 2009 IRS rule change that reduces expected renegotiation costs. Borrowers with high private use values of the property are more likely to default following this regulation, particularly when expected servicer renegotiation capacity is high. Our results suggest substantial asymmetric information between borrowers and lenders, as well as adverse consequences of principal forgiveness