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The Design of Foreclosure Punishments: You Just Cannot Walk Away!

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  • Don Schlagenhauf

    (Florida State University)

  • Carlos Garriga

    (Federal Reserve Bank of St. Louis)

Abstract

Foreclosure rates have soared during the recent housing crisis. In this paper we argue that exploring the implications of the legal environment pertinent to foreclosures is very relevant to the understanding of the macroeconomic transmission of the financial crises. Foreclosure law is designed to allocate the deficit between the current value of the property and the outstanding debt. In the United State, two different regimes coexist across states: no discharge and full discharge. The empirical evidence seems to suggest that states with full discharge exhibit foreclosure rates that are more sensitive to declines in house values. We study the quanitative importance of default punishments in the determination of foreclosure rates. We modify the housing model with the default option developed in Garriga and Schlagenhauf (2008) to allow for different allocations of deficits and the severity of (present and future) punishments. The model generates testable implications for tenure, housing size, and portfolio allocations consistent with the empirical evidence. Preliminary findings suggest that the design of punishment can have important macroeconomic consequences.

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Bibliographic Info

Paper provided by Society for Economic Dynamics in its series 2009 Meeting Papers with number 396.

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Date of creation: 2009
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Handle: RePEc:red:sed009:396

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Postal: Society for Economic Dynamics Christian Zimmermann Economic Research Federal Reserve Bank of St. Louis PO Box 442 St. Louis MO 63166-0442 USA
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  1. Storesletten, Kjetil & Telmer, Chris & Yaron, Amir, 2002. "Consumption and Risk Sharing Over the Life Cycle," Seminar Papers 702, Stockholm University, Institute for International Economic Studies.
  2. Morris A. Davis & Jonathan Heathcote, 2005. "Housing And The Business Cycle," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 46(3), pages 751-784, 08.
  3. Fran�ois Ortalo-Magné & Sven Rady, 2006. "Housing Market Dynamics: On the Contribution of Income Shocks and Credit Constraints ," Review of Economic Studies, Oxford University Press, vol. 73(2), pages 459-485.
  4. José-Víctor Ríos-Rull & Virginia Sánchez-Marcos, 2008. "An Aggregate Economy with Different Size Houses," Journal of the European Economic Association, MIT Press, vol. 6(2-3), pages 705-714, 04-05.
  5. Nobuhiro Kiyotaki & Alexander Michaelides & Kalin Nikolov, 2011. "Winners and Losers in Housing Markets," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 43, pages 255-296, 03.
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