Will the Mortgage Market Correct? How Households and Communities Would Fare If Risk Were Priced Well

81 Pages Posted: 6 Aug 2009

Date Written: August 5, 2009


The dominant narrative of the subprime lending crisis is that recent mortgage market problems are the fallout of the bursting of a speculative housing bubble. The conventional wisdom derived from bubbles past is that markets self-correct. Certainly, house prices increased unsustainably, but whether the deflating of the bubble is leading to a “correct” mortgage market is less clear. Yet wise public policy depends on the answer to that question. If the cause of the crisis is a cyclical swing that ultimately rights itself through market forces, then the appropriate policy response need only stabilize the market and help those knocked down in the pendulum’s arc. However, if the market will not self-correct, longer term policy changes are necessary.

This Article concludes that as a result of the crisis, lenders and investors are likely to identify and price the risk of foreclosure-related losses more accurately and in the process decrease foreclosure risk somewhat. But because the supply side can bear more foreclosure risk than borrowing households or third-party renters and communities, supply-side corrections alone will not result in a correctly functioning market.

Borrowing households will attempt to avoid overly-risky loans in the aftermath of the crisis, yet are unlikely to acquire either the ability to determine hich loans are overly-risky or the habit of consistently refusing these loans. Left to market devices, renters will never know which dwellings are security for overly-risky mortgages. The market will not force the transacting parties to internalize social costs of foreclosure, and therefore will produce overly-risky loans. Without policies that reduce foreclosure risk, borrowers will continue to misjudge it, renters will remain unable to account for it, and neighborhoods will not consistently benefit from mortgage transactions that take place along their streets.

Suggested Citation

Willis, Lauren E., Will the Mortgage Market Correct? How Households and Communities Would Fare If Risk Were Priced Well (August 5, 2009). Connecticut Law Review, Vol. 41, No. 4, 2009, Loyola-LA Legal Studies Paper No. 2009-25, Available at SSRN: https://ssrn.com/abstract=1444615

Lauren E. Willis (Contact Author)

Loyola Law School Los Angeles ( email )

919 Albany Street
Los Angeles, CA 90015-1211
United States
213-736-1086 (Phone)
213-380-3769 (Fax)

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