Judging Judicial Foreclosure

Abstract

For the third time in the last several decades, policymakers are contemplating an overhaul of mortgage-finance regulations. Despite the considerable attention paid to how ex ante regulations affect the availability of credit and the appropriateness of the mortgage products that lenders offer, our understanding of how the legal framework governing foreclosures — a form of ex post borrower protection — impacts mortgage lending is incomplete. Leveraging data on loan applicants that are geographically proximate and subject to the same federal mortgage-finance regulations and nearly identical state foreclosure regimes — but for the presence or absence of a judicial foreclosure requirement — this analysis enables the identification of the independent effects of judicial-foreclosure requirements on loan approval decisions and the share of approved applicants that are offered subprime loans.

I find that lenders adopt a more conservative posture in evaluating loan applications in jurisdictions where they must haul delinquent borrowers into court. All else equal, loan applications are less likely to be approved and approved borrowers are less likely to be offered subprime loans in judicial-foreclosure states. Further, some models indicate that these results may be amplified for borrowers with lower socio-economic status, suggesting that judicial supervision of foreclosures may have tempered one of the more flagrant practices of the subprime era: providing high-rate mortgages with a greater likelihood of default to lower-income and minority borrowers. These results suggest that, in contemplating changes to the regulation of mortgage lenders, policymakers should consider state foreclosure law to be among the tools in their regulatory toolkit.