Abstract:
On March 4, 2011, the New York Times described a settlement ("settlement") proposed by a consortium of state attorneys general (AGs) to large mortgage servicers. The claims to be settled reportedly relate to failures to follow existing procedural rules relating to the foreclosure process. The settlement would make dramatic changes in those rules, and reportedly require a mortgage loan principal reduction program of $20 to 25 billion. The purpose of this study is to review how such a settlement would affect the housing market and the larger economy.
The authors find that the proposed settlement would generate significant unintended negative consequences for housing and financial markets. In particular, we find that (1) the settlement is unlikely to provide broad or lasting benefits; (2) the settlement would be counterproductive in its overall effect because it would drive up the number of defaults and servicing costs; (3) the proposal would slow new home construction and consumer spending, and reduce access to credit; and (4) the increased costs imposed by the settlement, under some assumptions, could increase mortgage interest rates by 22 to 31 basis points per year. In light of all of these considerations, the authors conclude that the settlement would serve to extend, rather than end, the foreclosure crisis.
Commentary:
As should not be surprising in an article written by economists, this paper places excessive emphasis on the costs of foreclosure to the overall economy and fails to give sufficient, if any, weight to the costs to individuals and society resulting from the massive malfeasance by the mortgage servicing industry.
In the standard reduction by practitioners of the dismal science of homeowners into rather odious, coldly-calculating bottom-line machines devoid of morality or emotion (a characterization more apt for mortgage servicers), the authors repeatedly stress that homeowners would "strategically default" to gain mortgage modifications that they really do not need. This opinion is based on a study of lending by a South African finance company, making its application to the U.S. mortgage servicing industry somewhat suspect. It also fails to reflect the emotional, psychological and societal stigma and trauma from the foreclosure process that counter-balances this supposed lack of "moral hazard".
The paper also, despite recognizing the failures and sins of the mortgage servicing industry (admittedly, this recognition is contained only in a single sentence at the end of the paper and does not consider any of the costs of these bad acts, but it is still something of an admission), oddly assumes that "lenders will ration modifications to avoid making concessions to borrowers that strategically default" in a manner that best serves all parties. As seems typical, the utter disregard of any "moral hazard" by lenders is ignored.
The authors fail to present any credible solutions to either the illegal foreclosure practices or the more general economic problems other than allowing a "speedy recognition of losses".
Coupling a mandatory modification to the filing of a bankruptcy would more fully address the valid concerns raised, including providing a neutral party to determine the ability of homeowners to perform under a modification, elimination of other debts that increase the difficulty of compliance, and including a personal cost for homeowners in the stigma and extended oversight of bankruptcy that would avoid the over-hyped "moral hazard" risk of individuals willy-nilly seeking modifications that are either unnecessary or infeasible. For more information on such a proposal, see:
Detailed Explanation of the Principal Paydown Plan.PDF
For a copy of the Article, please see:
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1833729
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