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Reducing foreclosures

Author

Listed:
  • Christopher L. Foote
  • Kristopher S. Gerardi
  • Lorenz Goette
  • Paul S. Willen

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 the mortgage and the lender’s choice on 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. Rather, the typical problem appears to be a combination of household income shocks and an unprecedented fall in house prices. Regarding the small number of loan modifications to date, we show, both theoretically and empirically, that the efficiency of foreclosure for investors is a more plausible explanation for the low number of modifications 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.

Suggested Citation

  • Christopher L. Foote & Kristopher S. Gerardi & Lorenz Goette & Paul S. Willen, 2009. "Reducing foreclosures," Public Policy Discussion Paper 09-2, Federal Reserve Bank of Boston.
  • Handle: RePEc:fip:fedbpp:09-2
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    Citations

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    Cited by:

    1. Satyajit Chatterjee & Burcu Eyigungor, 2015. "A Quantitative Analysis of the US Housing and Mortgage Markets and the Foreclosure Crisis," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 18(2), pages 165-184, April.
    2. John Y. Campbell & João F. Cocco, 2015. "A Model of Mortgage Default," Journal of Finance, American Finance Association, vol. 70(4), pages 1495-1554, August.
    3. Cambpbell, John Y. & Jackson, Howell Edmunds & Madrian, Brigitte & Tufano, Peter, 2010. "The Regulation of Consumer Financial Products: An Introductory Essay with Four Case Studies," Scholarly Articles 4450128, Harvard Kennedy School of Government.
    4. Jeske, Karsten & Krueger, Dirk & Mitman, Kurt, 2011. "Housing and the Macroeconomy: The Role of Bailout Guarantees for Government Sponsored Enterprises," CEPR Discussion Papers 8624, C.E.P.R. Discussion Papers.
    5. M. Dietsch & C. Welter-Nicol, 2014. "Do LTV and DSTI caps make banks more resilient?," Débats économiques et financiers 13, Banque de France.
    6. Chan, Sewin & Gedal, Michael & Been, Vicki & Haughwout, Andrew, 2013. "The role of neighborhood characteristics in mortgage default risk: Evidence from New York City," Journal of Housing Economics, Elsevier, vol. 22(2), pages 100-118.
    7. Dietsch, Michel & Petey, Joël, 2015. "The credit-risk implications of home ownership promotion: The effects of public subsidies and adjustable-rate loans," Journal of Housing Economics, Elsevier, vol. 28(C), pages 103-120.
    8. Karikari, John A., 2013. "Why homeowners’ documentation went missing under the Home Affordable Mortgage Program (HAMP)?: An analysis of strategic behavior of homeowners and servicers," Journal of Housing Economics, Elsevier, vol. 22(2), pages 146-162.
    9. Das, Sanjiv R. & Meadows, Ray, 2013. "Strategic loan modification: An options-based response to strategic default," Journal of Banking & Finance, Elsevier, vol. 37(2), pages 636-647.
    10. John Geanakoplos, 2010. "Solving the Present Crisis and Managing the Leverage Cycle," Cowles Foundation Discussion Papers 1751, Cowles Foundation for Research in Economics, Yale University.

    More about this item

    Keywords

    Foreclosure;

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