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Reducing Foreclosures: No Easy Answers

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  • Christopher Foote
  • Kristopher Gerardi
  • Lorenz Goette
  • Paul Willen

Abstract

This paper takes a skeptical look at a leading argument about what is causing the foreclosure crisis and distills some potential lessons for policy. 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 the extension of temporary help to borrowers suffering adverse life events like job loss could prevent more foreclosures than a policy that makes mortgages more "affordable" on a long-term basis.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 15063.

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Date of creation: Jun 2009
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Publication status: published as Acemoglu, Daron, Kenneth Rogoff, and Michael Woodford (eds.) NBER Macroeconomics Annual 2009, Volume 24. Chicago: University of Chicago Press, 2010.
Handle: RePEc:nbr:nberwo:15063

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  1. 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.
  2. Dell’Ariccia, G. & Igan, D. & Laeven, L., 2009. "Credit Booms and Lending Standards: Evidence from the Subprime Mortgage Market," Discussion Paper 2009-46 S, Tilburg University, Center for Economic Research.
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  7. Atif Mian & Amir Sufi, 2008. "The Consequences of Mortgage Credit Expansion: Evidence from the 2007 Mortgage Default Crisis," NBER Working Papers 13936, National Bureau of Economic Research, Inc.
  8. Carl F. Behrens, 1952. "Appendices and Index to "Commercial Bank Activities in Urban Mortgage Financing"," NBER Chapters, in: Commercial Bank Activities in Urban Mortgage Financing, pages 85-125 National Bureau of Economic Research, Inc.
  9. Danis, Michelle A. & Pennington-Cross, Anthony, 2008. "The delinquency of subprime mortgages," Journal of Economics and Business, Elsevier, vol. 60(1-2), pages 67-90.
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  17. Kristopher S. Gerardi & Paul S. Willen, 2009. "Subprime mortgages, foreclosures, and urban neighborhoods," Working Paper 2009-01, Federal Reserve Bank of Atlanta.
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  20. 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.).
  21. 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.
  22. Kiefer, Nicholas M, 1988. "Economic Duration Data and Hazard Functions," Journal of Economic Literature, American Economic Association, vol. 26(2), pages 646-79, June.
  23. Carl F. Behrens, 1952. "Commercial Bank Activities in Urban Mortgage Financing," NBER Books, National Bureau of Economic Research, Inc, number behr52-1, October.
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