Reducing foreclosures

Christopher Foote, Kristopher Gerardi, Lorenz Goette and Paul Willen

No 09-2, Public Policy Discussion Paper from Federal Reserve Bank of Boston

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.

Keywords: Foreclosure (search for similar items in EconPapers)
Date: 2009
New Economics Papers: this item is included in nep-ure
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Citations: View citations in EconPapers (16)

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