Adam Guren on Foreclosures and Housing Policy
Like many economists, Boston University’s Adam Guren asserts that the failure to develop and implement effective housing market policy was a major contributing factor to the inception and duration of the Great Recession; during a lunch talk he gave to a packed room of Woodrow Wilson School students last month, he explained the many ways his recent research supports this notion.
Most notably, Guren argued that one common misperception--that homeowners at the time were irresponsibly choosing to default on their “underwater” mortgages--fueled many of the poor decisions that policy leaders made in response to the flood of foreclosures.
That supposedly irresponsible homeowner would be engaging in what Guren calls a “strategic” default: The idea being that this borrower is making a rational decision to ignore their home loan payment 1) because of their negative equity and 2) in favor of some other external incentive. Instead, Guren finds that the data suggests an alternative explanation that he calls a “double trigger” default: Most homeowners that defaulted on their mortgages during the Great Recession did so because their negative equity was compounded by one or more other negative household shocks (such as job loss or a health problem).
According to the available data, Guren found that the median sub-prime borrower did not default strategically during the crisis until their equity was -67%. And very few of these borrowers went from “current” to “90 days late” or more on their payments without at least trying to make one payment. In fact, a mere 14% of those who defaulted on their mortgages had enough liquid assets to make a single payment.
“This changes the way we think about policy,” Guren says. “These borrowers had bad circumstances, not bad intentions.”
The two major policies instated to address the massive housing crisis were HAMP (the Home Affordable Modification Program, designed for homeowners facing financial hardship--Guren’s “double trigger” default group) and HARP (the Home Affordable Refinance Program, designed for paid-up borrowers who were facing significant negative equity--those least likely to default, according to Guren).
HAMP was by most accounts ineffective, only reaching about ⅓ of its target; HARP was considerably more successful, bearing out Guren’s assertion that most homeowners wanted both to remain in their homes and to stay current on their loan payments--even though in the end even HARP still fell short of its initial goal. Further, both programs required the borrower’s loan be serviced by Fannie Mae or Freddie Mac, blocking out a considerable number of distressed sub-prime borrowers. Also, for both programs, many lenders were reluctant to participate, often due to overloaded and insufficiently trained loan servicing staff.
So what would the ideal policy look like? Guren discussed whether the data suggests it would be preferable to a) reduce the principal owed on an at-risk mortgage or b) reduce the monthly payment by lengthening the repayment term or lowering the interest rate.
Guren suggested that the latter option--lowering monthly payments--would likely have a more favorable effect on the overall economy. He also offered an idea based on his observations of “judicial” versus “recourse” states (the difference being that in “judicial” states--there are 13 of them--foreclosures must go through the court system). In “judicial” states, the foreclosure process goes much slower, and this seemed to reduce the depth of the recession as felt locally. He posited that slowing down the foreclosure process in every state might be beneficial for the overall economy.
In conclusion, Guren explained the nature of his future work: To study how we might redesign mortgages to reduce foreclosures, and to avoid such housing market volatility, going forward.
View the slides from Guren’s talk >