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Reducing foreclosures: no easy answers

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

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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  1. Charles Himmelberg & Christopher Mayer & Todd Sinai, 2005. "Assessing high house prices: bubbles, fundamentals, and misperceptions," Staff Reports 218, Federal Reserve Bank of New York.
  2. Foote, Christopher L. & Gerardi, Kristopher & Willen, Paul S., 2008. "Negative equity and foreclosure: Theory and evidence," Journal of Urban Economics, Elsevier, vol. 64(2), pages 234-245, September.
  3. Deng, Yongheng & Quigley, John M. & Van Order, Robert, 1999. "Mortgage Terminations, Heterogeneity, and the Exercise of Mortgage Options," Berkeley Program on Housing and Urban Policy, Working Paper Series qt96r560pg, Berkeley Program on Housing and Urban Policy.
  4. J. E. Morton, 1956. "Urban Mortgage Lending: Comparative Markets and Experience," NBER Books, National Bureau of Economic Research, Inc, number mort56-1, May.
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  6. 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.).
  7. Michelle A. Danis & Anthony Pennington-Cross, 2005. "The delinquency of subprime mortgages," Working Papers 2005-022, Federal Reserve Bank of St. Louis.
  8. repec:att:wimass:9722 is not listed on IDEAS
  9. Piskorski, Tomasz & Seru, Amit & Vig, Vikrant, 2010. "Securitization and distressed loan renegotiation: Evidence from the subprime mortgage crisis," Journal of Financial Economics, Elsevier, vol. 97(3), pages 369-397, September.
  10. James M. Poterba, 1983. "Tax Subsidies to Owner-occupied Housing: An Asset Market Approach," Working papers 339, Massachusetts Institute of Technology (MIT), Department of Economics.
  11. Larry Cordell & Karen Dynan & Andreas Lehnert & Nellie Liang & Eileen Mauskopf, 2008. "The incentives of mortgage servicers: myths and realities," Finance and Economics Discussion Series 2008-46, Board of Governors of the Federal Reserve System (U.S.).
  12. Paul S. Willen & Adam Hale Shapiro & Kristopher Gerardi, 2008. "Subprime Outcomes: Risky Mortgages, Homeownership Experiences, and Foreclosures," 2008 Meeting Papers 345, Society for Economic Dynamics.
  13. Pierre-Olivier Gourinchas & Jonathan A. Parker, 1999. "Consumption Over the Life Cycle," NBER Working Papers 7271, National Bureau of Economic Research, Inc.
  14. 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.
  15. DellAriccia, Giovanni & Igan, Deniz & Laeven, Luc, 2008. "Credit Booms and Lending Standards: Evidence From The Subprime Mortgage Market," CEPR Discussion Papers 6683, C.E.P.R. Discussion Papers.
  16. Kristopher S. Gerardi & Paul S. Willen, 2008. "Subprime mortgages, foreclosures, and urban neighborhoods," Public Policy Discussion Paper 08-6, Federal Reserve Bank of Boston.
  17. J. E. Morton, 1956. "Introduction to "Urban Mortgage Lending: Comparative Markets and Experience"," NBER Chapters, in: Urban Mortgage Lending: Comparative Markets and Experience, pages 1-13 National Bureau of Economic Research, Inc.
  18. 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.
  19. 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.
  20. C. Lowell Harriss, 1951. "History and Policies of the Home Owners' Loan Corporation," NBER Books, National Bureau of Economic Research, Inc, number harr51-1, May.
  21. Carl F. Behrens, 1952. "Introduction to "Commercial Bank Activities in Urban Mortgage Financing"," NBER Chapters, in: Commercial Bank Activities in Urban Mortgage Financing, pages 1-13 National Bureau of Economic Research, Inc.
  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. 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.
  24. Atif Mian & Amir Sufi, 2009. "The Consequences of Mortgage Credit Expansion: Evidence from the U.S. Mortgage Default Crisis," The Quarterly Journal of Economics, MIT Press, vol. 124(4), pages 1449-1496, November.
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