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Reducing foreclosures: no easy answers

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Author Info
Christopher Foote
Kristopher Gerardi
Lorenz Goette
Paul S. Willen

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Abstract

This paper takes a skeptical look at a leading argument about what is causing the foreclosure crisis and what should be done to stop it. We use an economic model to focus on two key decisions: the borrower's choice to default on a mortgage and the lender's subsequent choice whether to renegotiate or modify the loan. The theoretical model and econometric analysis illustrate that unaffordable loans, defined as those with high mortgage payments relative to income at origination, are unlikely to be the main reason that borrowers decide to default. In addition, this paper provides theoretical results and empirical evidence supporting the hypothesis that the efficiency of foreclosure for investors is a more plausible explanation for the low number of modifications to date than contract frictions related to securitization agreements between servicers and investors. While investors might be foreclosing when it would be socially efficient to modify, there is little evidence to suggest they are acting against their own interests when they do so. An important implication of our analysis is that policies designed to reduce foreclosures should focus on ameliorating the immediate effects of job loss and other adverse life events rather than modifying loans to make them more affordable on a long-term basis.

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Paper provided by Federal Reserve Bank of Atlanta in its series Working Paper with number 2009-15.

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Date of creation: 2009
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Handle: RePEc:fip:fedawp:2009-15

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Related research
Keywords: Foreclosure ; Mortgage loans ; Mortgage-backed securities;

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  1. Charles Himmelberg & Christopher Mayer & Todd Sinai, 2005. "Assessing High House Prices: Bubbles, Fundamentals, and Misperceptions," NBER Working Papers 11643, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  2. Yongheng Deng & John M. Quigley & Robert Van Order, . "Mortgage Terminations, Heterogeneity and the Exercise of Mortgage Options," Zell/Lurie Center Working Papers 322, Wharton School Samuel Zell and Robert Lurie Real Estate Center, University of Pennsylvania. [Downloadable!] (restricted)
    Other versions:
  3. Christopher L. Foote & Kristopher Gerardi & Paul S. Willen, 2008. "Negative equity and foreclosure: theory and evidence," Public Policy Discussion Paper 08-3, Federal Reserve Bank of Boston. [Downloadable!]
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  4. repec:bep:eapadv:v:9:y:2009:i:3:p:2232-2232 is not listed on IDEAS
  5. Pierre-Olivier Gourinchas & Jonathan A. Parker, 2002. "Consumption Over the Life Cycle," Econometrica, Econometric Society, vol. 70(1), pages 47-89, January. [Downloadable!] (restricted)
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  6. Kau James B. & Keenan Donald C. & Kim Taewon, 1994. "Default Probabilities for Mortgages," Journal of Urban Economics, Elsevier, vol. 35(3), pages 278-296, May. [Downloadable!] (restricted)
  7. Shane M. Sherlund, 2008. "The past, present, and future of subprime mortgages," Finance and Economics Discussion Series 2008-63, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
  8. Kristopher S. Gerardi & Paul S. Willen, 2009. "Subprime mortgages, foreclosures, and urban neighborhoods," Working Paper 2009-01, Federal Reserve Bank of Atlanta. [Downloadable!]
  9. Foote, Christopher L. & Gerardi, Kristopher & Goette, Lorenz & Willen, Paul S., 2008. "Just the facts: An initial analysis of subprime's role in the housing crisis," Journal of Housing Economics, Elsevier, vol. 17(4), pages 291-305, December. [Downloadable!] (restricted)
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This page was last updated on 2009-11-20.

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