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The Case for Foreclosures, by Steven Landsburg
None of these foreclosed houses is going to disappear. After a foreclosure, one family moves out, and another moves in. We see the sad faces of the people moving out, but we don't as often see the happy faces of the new homeowners moving in. Nevertheless, those happy faces are out there, and we should not discount them.
Here is more. I take the case against foreclosures to be the following. The people getting kicked out lose their credit ratings and in the medium term they spend less. The people moving in presumably have higher credit ratings but they probably aren't rich. They transfer a big chunk of their liquid wealth to a possibly-low-propensity-to-spend financial institution. So foreclosures lower nominal aggregate demand and in times of a downturn this can be bad.
Landsburg's title may just be provocative but I would make a distinction between the case for allowing foreclosures (I do not advocate that the federal government rewrite the mortgage contracts, although renegotiation could be made easier) and the case for foreclosures. I should note he is quite correct to insist that foreclosure victims are hardly among the world's -- or even America's -- neediest cases. If you think government can do anything well at all, ask what it can do for underprivileged young children. On both justice and efficiency grounds the greatest potential gains lie there. And continued home ownership is not the main thing they need.
Posted by Tyler Cowen on March 3, 2008 at 03:49 PM in Economics | Permalink
Comments
There's a pretty strong efficiency justification for having the government promise to step in when people get robbed, even if the robbed are not objectively poor post-robbery. To the extent that this crisis was caused by lender fraud (I know it was also caused partly by borrower fraud), there's your justification for intervention.
Posted by: David J. Balan at Mar 3, 2008 4:18:52 PM
but often the problem is not about credit rating but mortgage value.
when the house is not worth the mortgage then families stop paying it and move away.
then banks have to sell undervalue and the mechanism is self feeded (most like real estate price increasings in the good days).
so, sad faces, happy faces. We do not see banker's...
Posted by: Kerub at Mar 3, 2008 4:20:39 PM
As I document here foreclosures DO NOT leave homes as they were before the foreclosure. The home on my street was abandoned and destroyed by a frozen water pipe. OThers are vandalized. Others in places like Buffalo and Cleveland are abandoned, destroying entire neighborhoods.
Posted by: Buzzcut at Mar 3, 2008 4:30:28 PM
Wouldn't we expect those losing their homes to spend more? They'll stop
paying the expensive mortgage and start paying less in rent. Sure, their
credit will be damaged. That just means it will be harder to buy a home;
they probably will continue to have their credit cards, and they'll have
more each month to spend.
Posted by: Thomas at Mar 3, 2008 4:34:38 PM
I find myself in complete agreement with Tyler (and I don't often agree with him). With the incentives legislators operate under, it is very unrealistic to expect them to be able to correct for problems like this. If taxpayer money is going to be spent, there are undoubtedly better things to spend it on.
Posted by: Grant at Mar 3, 2008 4:34:55 PM
Buzzcut,
Shouldn't we be suing those banks doing the foreclosure for externalities caused by not taking care of the properties they reclaim?
That's separate from the issue of the foreclosure itself.
And for those with 100% mortgages and no equity, I'm not sure how they're the victims. They got to live in a property they should never have owned in the first place. In effect they were renting with an option to own if the market had gone up.
Posted by: computer at Mar 3, 2008 4:37:02 PM
The reason foreclosures are a good thing, is that banks will eventually clearance sale houses (when their regulators force them to do so), foreclosures put assets in the hands of an entity that is evaluated by their return on assets. The government should make foreclosure (and REO sale) a faster process (to reduce the transaction costs Buzzcut mentions).
I'm about to be a newlywed with a high disposable income, but I'm not going to buy into a market with 4% cap rates, especially with non taxible investments yielding 5+% now. Cap rates should be 8% with the subsidy in this market.
Posted by: nelsonal at Mar 3, 2008 4:42:16 PM
There is a negative externality due to foreclosures--it lowers the market value of surrounding houses even though these people are making timely repayment. The credit for this arguments goes to Congressman Barney Frank. He mentioned this in the Lunch with Financial Times column. I am surprised that this does not gets mentioned enough.
Posted by: Asif Dowla at Mar 3, 2008 5:30:03 PM
There is a negative externality due to foreclosures--it lowers the market value of surrounding houses even though these people are making timely repayment. The credit for this arguments goes to Congressman Barney Frank. He mentioned this in the Lunch with Financial Times column. I am surprised that this does not gets mentioned enough.
Posted by: Asif Dowla at Mar 3, 2008 5:30:41 PM
The argument is completely correct, but mises the point. The problem is not the impact on individuals. The problem is the impact on financial institutions. Does the process lead to more then just a few small banks failing.
Posted by: spencer at Mar 3, 2008 5:36:51 PM
There is a negative externality due to foreclosures--it lowers the market value of surrounding houses even though these people are making timely repayment.
What you've just described is a pecuniary externality due to foreclosures, not a negative one.
Posted by: Paul Zrimsek at Mar 3, 2008 5:36:51 PM
Parable of the wise young man:
The wise young man saw that he could not afford to buy a home early on in the housing bubble and so invested his money in other assets. He saved and invested money waiting for his chance. He saw the not so wise buy and enjoy homes bought at inflated prices and he watched as their net worth leap ahead of his. He was temped to buy but when he calculated he did not see that to buy was wise and so he warned the not so wise and waited. All the time he was taxed on the earnings of his savings and investments while the not so wise deducted their mortgage interest. Then the bubble began to burst and the foreclosures came and he thought that this might be his chance to get a home but the Government stepped in and used the tax dollars collected on his investments to bail out the not so wise.
Is deterrence to folly not a benefit to letting the foolish be foreclosed on?
Posted by: Floccina at Mar 3, 2008 5:45:01 PM
Paul:
Well, it is affecting the surrounding homeowners negatively by lowering the value of their houses even though they had nothing to do with the default of their neighbor. This is a classic example of externalily--third party is being affected and negatively.
Posted by: Asif Dowla at Mar 3, 2008 5:50:45 PM
Asif,
Another perspctive is that it is not lowering the value of their houses, but rather making them aware of the real value of the houses.
I suppose if there are numerous foreclsures in an area, it would make the perceived desirableness less, (i,e, create a negative feedback loop).
I haven't seen data on foreclosures actually lowering other property values though.
Tony
Posted by: Tony K at Mar 3, 2008 5:59:41 PM
Asif,
It's not a negative externality for those who can now afford to buy the house at a lower price.
Posted by: fg556 at Mar 3, 2008 6:33:42 PM
Surely there are some deadweight losses associated with the transfer of ownership. (If nothing else, the family that is foreclosing has to bear some sort of transaction costs associated with either the mortgage company or the moving company.) If that's not a sad face for us economists, I don't know what is.
Posted by: Michael Powell at Mar 3, 2008 6:33:56 PM
Asif was not clear enough in his argument on negative externalities to identify whether it should be labeled pecuniary or technological. If his argument is that the foreclosed house represents an increase in supply and thus lowering of price, then it is pecuniary. If his argument is that potential buyers prefer to not live next door to a foreclosed unit because of that label, then it is technological.
Either way it sounds like I should make my neighbors pay me a bribe to continue making my mortgage payments. Notice they would only care if they were presently putting their house on the market today.
Posted by: Justin Ross at Mar 3, 2008 6:34:33 PM
"Well, it is affecting the surrounding homeowners negatively by lowering the value of their houses even though they had nothing to do with the default of their neighbor. This is a classic example of externalily--third party is being affected and negatively."
This is also a classic example of a pecuniary externality that is irrelevant from a welfare perspective. (Not all pecuniary externalities have this status.)
Posted by: Michael Powell at Mar 3, 2008 6:36:11 PM
"Well, it is affecting the surrounding homeowners negatively by lowering the value of their houses even though they had nothing to do with the default of their neighbor. This is a classic example of externalily--third party is being affected and negatively."
It is a negative externality but it is exactly balanced by an equal positive externality (namely the cheaper price someone who is buying will pay for the house).
Posted by: assman at Mar 3, 2008 6:55:04 PM
The Englewood community in Chicago suffered a housing crisis in the late 70's. White flight was an issue as lower income African Americans moved into the community. The Federal government came in with loan guarantees. Whites trying to flee were happy, they could easily find buyers for their house and prices declined less then they would have.
African Americans were happy to be able to buy homes. The banks were happy to lend because much of the risk of the loans had been removed.
What happened? Marginal borrowers started to default on the new loans. Banks discovered that rapid foreclosures actually meant quicker returns as they turned the loans to the Federal government. But hundreds of empty house depressed prices. Crime increased often occurring in vacated homes. Even the people who stayed in their homes disinvested in them. They let the homes decline in value rather then maintain them. Those who could afford to move out did. Middle class African American families fled faster then the whites who had left just a few years before. Housing prices went into a free fall never to recover to this day. Those left behind saw an increase in drug dealing, prostitution, and one of the highest murder rates in the world.
So please, do not claim that an increase in foreclosures can not have a negative externality on communities
Posted by: DanC at Mar 3, 2008 7:29:02 PM
I would separate the notion that foreclosures are a good thing individually (versus a government intervention to keep people in homes by rewriting their contract) and the notion that they are good in aggregate for the economy. In order to assume the latter, we have to posit that people moving into homes that were foreclosed upon have at least the same desire for those homes as the people who left them. then we have to assume that the process by which new owners are found is relatively costless and that problems in the credit market don't lead those new buyers to paying more for the house (as the supply of credit is limited) than they should.
Even given all that, we have to accept a 'broken windows' notion of welfare here in order to see foreclosures as goods based on the gains of the new owners.
Posted by: Adam Hyland at Mar 3, 2008 7:31:24 PM
The lowered values of homes in the surrounding area is usually mostly a pecuniary externality, but to some extent it is also usually at least partially a result of some bona fide negative externalities (the neighbors yard gets overgrown, their pool turns into a bug infested toxic reservoir, squatters move in, etc).
And then there are all the deadweight losses. Loss mitigation specialists, real estate specialists, appraisers, inspectors, all essentially wasted efforts compared to the alternative letting the original homeowner stay.
Foreclosures are a lose-lose-lose proposition - and should be avoided when reasonably possible. But if someone lives in a home that they truly can't afford, even at the new (presumably lower) market value, then there really is no reasonable possibility to avoid foreclosure (well, other than a short sale or a deed in lieu, anyway).
Posted by: Anthony at Mar 3, 2008 8:37:05 PM
"None of these foreclosed houses is going to disappear."
There was an article recently in the Las Vegas Review Journal about how approximately 50% of the foreclosures here have been trashed -- either by angry vacating owners or tenants, or by vandals who break in to steal things (appliances, fixtures, copper pipes and wire ripped from the walls, etc.). These houses have effectively "disappeared" because the amount of work to make them livable again will be quite costly.
Posted by: Jacqueline at Mar 3, 2008 8:39:39 PM
Does anyone know what condition the houses were in 1986 when the combination real estate bubble and economic depression hit Texas?
I suspect there are lessons to be learned there.
Posted by: happyjuggler0 at Mar 3, 2008 8:50:29 PM
I hope -- and encourage -- everyone underwater on their mortgage to "walk away"; let's get these prices adjusted downward...sooner rather than later.
You who whine about the "negative externality": Did you whine about the "positive externality" of your neighbor's home as a "comparable" on the way up? I don't think so. Whenever I hear the term "granite countertop", it makes me want to puke.
I looked to buy in 2002 and again in 2004. Anyone with common sense could see it was a bubble; I used to google "housing bubble" and read news stories about the insanity loooooong before Ben started the "housing bubble blog".
Instead, I put my money in QQQQ and SPY and rode that pony uphill for 3 years -- I'll let you in on a big secret: while the housing bubble was inflating so was a liquid, well-diversified portfolio of equities. Then flipped to cash beginning of 2007...have been buying commodities and riding oil, food, and precious metals uphill. (Now, anyone with a brain is betting on HeliBen trying to inflate his way out of this mess!)
Can't wait to buy a house for peanuts. {Of course, with oil at $103 today, I think I'll just wait a while longer...}
Sadly, the one thing I can't do is keep the governments hands off the money I earned in capital gains, as everyone is so eager to bail out all of these greedy fools (or idiots) who used their homes as ATMs.
Posted by: Waiting 2Buy at Mar 3, 2008 8:58:15 PM
