Reducing Foreclosures

52 Pages Posted: 21 May 2009

See all articles by Christopher L. Foote

Christopher L. Foote

Federal Reserve Bank of Boston

Kristopher Gerardi

Federal Reserve Bank of Atlanta

Lorenz Goette

University of Lausanne; Centre for Economic Policy Research (CEPR); IZA Institute of Labor Economics

Paul Willen

Federal Reserve Bank of Boston - Research Department; National Bureau of Economic Research (NBER)

Date Written: April 8, 2009

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.

JEL Classification: D11, D12, G21

Suggested Citation

Foote, Christopher L. and Gerardi, Kristopher S. and Goette, Lorenz F. and Willen, Paul S., Reducing Foreclosures (April 8, 2009). FRB of Boston Public Policy Discussion Paper No. 09-2, Available at SSRN: https://ssrn.com/abstract=1407729 or http://dx.doi.org/10.2139/ssrn.1407729

Christopher L. Foote (Contact Author)

Federal Reserve Bank of Boston ( email )

600 Atlantic Avenue
Boston, MA 02210
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Kristopher S. Gerardi

Federal Reserve Bank of Atlanta ( email )

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Atlanta, GA 30309-4470
United States
404-498-8561 (Phone)

HOME PAGE: http://sites.google.com/site/kristophergerardishomepage/

Lorenz F. Goette

University of Lausanne ( email )

Department of Economics
Batiment Internef
Lausanne, 1015
Switzerland
(021) 692'3496 (Phone)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

HOME PAGE: http://www.iza.org

Paul S. Willen

Federal Reserve Bank of Boston - Research Department ( email )

600 Atlantic Avenue
Boston, MA 02210
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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