Reducing Foreclosures: No Easy Answers

54 Pages Posted: 16 Jun 2009 Last revised: 29 Aug 2024

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)

Multiple version iconThere are 2 versions of this paper

Date Written: June 2009

Abstract

This paper takes a skeptical look at a leading argument about what is causing the foreclosure crisis and distills some potential lessons for policy. 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 the extension of temporary help to borrowers suffering adverse life events like job loss could prevent more foreclosures than a policy that makes mortgages more "affordable" on a long-term basis.

Suggested Citation

Foote, Christopher L. and Gerardi, Kristopher S. and Goette, Lorenz F. and Willen, Paul S., Reducing Foreclosures: No Easy Answers (June 2009). NBER Working Paper No. w15063, Available at SSRN: https://ssrn.com/abstract=1418921

Christopher L. Foote

Federal Reserve Bank of Boston ( email )

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Kristopher S. Gerardi

Federal Reserve Bank of Atlanta ( email )

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Lorenz F. Goette

University of Lausanne ( email )

Department of Economics
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Switzerland
(021) 692'3496 (Phone)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

IZA Institute of Labor Economics

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Germany

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

Paul S. Willen (Contact Author)

Federal Reserve Bank of Boston - Research Department ( email )

600 Atlantic Avenue
Boston, MA 02210
United States

National Bureau of Economic Research (NBER)

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Cambridge, MA 02138
United States

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