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Real Estate Research provides analysis of topical research and current issues in the fields of housing and real estate economics. Authors for the blog include the Atlanta Fed's Jessica Dill, Kristopher Gerardi, Carl Hudson, and analysts, as well as the Boston Fed's Christopher Foote and Paul Willen.

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March 5, 2014

Government Involvement in Residential Mortgage Markets

With the federal funds rate effectively at the zero lower bound, the Federal Reserve has used unconventional forms of monetary policy. Specifically, the central bank has issued forward guidance about the policy path and purchased large amounts of U.S. Treasury bonds and agency mortgage-backed securities (MBS) in an effort to lower long-term interest rates. In the case of agency MBS purchases, a goal was to stimulate the housing market by lowering mortgage rates. Two papers presented at the recent Atlanta Fed/University of North Carolina—Charlotte conference, "Government Involvement in Residential Mortgage Markets," examine the extent to which the Federal Reserve has been successful.

Unanticipated announcements of new large-scale asset purchase programs (LSAPs), or changes in these programs, should have an immediate impact on interest rates under the assumption that the total stock of purchases is what matters. On the other hand, the flow of purchases may independently influence markets through portfolio rebalancing—that is, investors reacting to the removal of duration and convexity from the market—and liquidity effects—that is, ease of reselling assets in the future. Diana Hancock and Wayne Passmore conduct an empirical analysis of the differing effects of the LSAPs in their paper, "How the Federal Reserve's Large-Scale Asset Purchases Influence MBS Yields and Mortgage Rates." Using weekly data from July 2000 to June 2013, the authors estimate a model of MBS yields that controls for market expectations about future interest rates and find that the Federal Reserve's market share of MBSs and Treasuries are negatively related to MBS yields. Under their model, the Fed's holdings of MBSs has lowered MBS yields by 54 basis points and the Treasury holdings have pushed down the MBS yields another 70 basis points. This finding is consistent with portfolio rebalancing and liquidity effects being important determinants of MBS yields.

The finding is important because it suggests that agency MBS yields and mortgage rates will rise when the Federal Reserve reduces its MBS purchases—even if the Fed successfully signals that it intends to keep rates low for an extended time. On the margin, this could serve to dampen housing market activity, including refinancing. Since the beginning of the third phase of quantitative easing (QE3), the Fed's MBS market share has grown from around 17 percent to nearly 24 percent. Given the estimate that each percentage point increase in market share pushes MBS yields down by 2.3 basis points, reducing the Fed’s MBS market share back to a pre-QE3 level would push MBS yields up by around 16 basis points, which is unlikely to be economically meaningful.

While the cost of mortgage refinancing is borne by MBS investors, most of the policy attention is placed on the benefit to borrowers through an increase in their disposable income. In cases where borrowers are underwater and having difficulty making mortgage payments, refinancing can ease borrowers’ financial distress. In "The Effect of Mortgage Payment Reduction on Default: Evidence from the Home Affordable Refinance Program," Jun Zhu, Jared Janowiak, Lu Ji, Kadiri Karamon, and Douglas McManus estimate that during the 2009 to 2012 period, a 10 percent reduction in monthly mortgage payments for participants in Freddie Mac’s Home Affordable Refinance Program (HARP) resulted in a 12 percent reduction in the monthly default hazard for 30-year fixed rate conventional-conforming mortgages. This likely helped slow the flow of mortgages entering the foreclosure pipeline and gave neighborhoods time to stabilize.

Government involvement in residential mortgage markets takes many forms (see the conference website for papers that examine other forms of intervention). Taken together, the papers discussed here provide evidence that the Federal Reserve's LSAPs and Freddie Mac's HARP did put downward pressure on longer-term interest rates and facilitated refinancing activity that helped to support housing and mortgage markets. The tapering of the MBS LSAPs should not be a cause for concern. The Fed’s strong forward guidance combined with the slow, judicious pace of the taper imply that stagnation of the housing market is unlikely.

Photo of Carl HudsonBy Carl Hudson, Director, Center for Real Estate Analytics in the Atlanta Fed's research department, and

April 26, 2012

Can home loan modification through the 60/40 Plan really save the housing sector?

In a recent article in the Federal Reserve Bank of St. Louis Review, Manuel Santos, a professor at the University of Miami, claims to offer a simple solution to "save the housing sector." Called the "60/40 Plan," his proposal is the centerpiece of a business called 60/40 The Plan Inc. Santos’s article is, in our opinion, written less like an academic article and more like promotional material.

The developer of the 60/40 Plan, Gustavo Diaz, is seeking a patent for the proposal. Unfortunately for the stressed mortgage market, his idea is simply a specific variant of a long-standing mortgage-servicing practice known as "principal forbearance." In general, principal forbearance occurs when the mortgage lender grants a temporary reduction of a borrower’s monthly mortgage payment, often reducing the payment by a significant fraction, with the stipulation that the borrower repay this benefit, with interest, at a later date.

Principal forbearance is a loss-mitigation tool that mortgage lenders and servicers have been using for decades. In fact, Fannie Mae and Freddie Mac are currently using this technique as a loss mitigation tool and alternative to principal forgiveness (which Federal Housing Finance Agency Acting Director Edward DeMarco discussed here). Private mortgage lenders have also widely used principal forbearance, especially in the first few years of the recent foreclosure crisis.

As articulated in Diaz’s 60/40 Plan, principal forbearance simply splits a distressed borrower’s current principal balance into two parts: a 60 percent share that will fully amortize over 30 years and be subject to interest payments at market rates, and a 40 percent share that is treated as a zero-interest balloon loan due at the time of sale.

Of course, in practice, the optimal shares and other terms of a principal forbearance program should be, and often are in practice, based on a given household’s financial situation. One size does not fit all. Professor Santos advocates the 60/40 Plan in large part because it is, in the language of economists, "incentive compatible." What this means is that borrowers who need assistance with their mortgage payments will find the program helpful and borrowers who do not need assistance will not find the program very appealing and thus will have little incentive to pretend to be a borrower in need of help in order to qualify for the program.

He writes: "It is important to understand that the 60/40 Plan builds on financial postulates and incentive compatible mechanisms that can be firmly implemented. It is designed as a first-best contract between the homeowner and the lender by holding onto some basic principles of incentive theory."

We agree completely with this sentiment. In fact, one of us wrote an article almost five years ago that advocated a policy of principal forbearance over principal forgiveness for exactly these reasons. Thus, the 60/40 Plan is not a novel concept, as Professor Santos seems to believe. But even more problematic, principal forbearance, as we have come to realize over the past few years, is not a panacea for the housing market for several reasons. First, it is really only helpful and appealing to borrowers that have temporary cash-flow problems who do not wish to move. This is because under the 60/40 Plan and principal forbearance in general, a borrower remains in a position of negative equity, which makes it virtually impossible to sell, since the borrower would need to come up with the amount of negative equity in cash to repay the entire principal balance of the mortgage at closing. For example, in the numerical example that Professor Santos works through to illustrate how the 60/40 Plan would work in practice, the borrower remains in a position of negative equity for 15 years. Thus, if a cash-strapped borrower needs to move immediately, or even a few years down the road, default (or re-default) is very likely.

Second, carrying 40 percent of the mortgage at a zero (or below market) interest rate imposes significant costs on the lender or investor. (These costs are viewed as being offset by savings from avoiding foreclosure.) Nevertheless, principal forbearance is not always going to be a positive net-present-value proposition; this depends on the share being protected (40 percent is quite high), the amortization schedule (30 years is very long), the discount rate, and the re-default rate. Indeed, Professor Santos seemingly assumes no re-default despite the fact that under the plan a borrower would remain in negative equity for a very long time, as we discussed above.

Third, most distressed mortgages are not held by depository institutions as whole loans. Fannie Mae and Freddie Mac have been able to selectively employ principal forbearance because they make investors whole in terms of the original promised principal and interest payments. This is not true for private-label securitizations, and there have been ongoing disagreements between investors and servicers as to optimal loss-mitigation strategies. (And there is no reason to think this proposal would not be similarly controversial.) The 60/40 Plan also seemingly ignores the significant complications posed by existing second liens and mortgage insurance policies.

Finally, Professor Santos claims that the 40 percent zero-coupon balloon shares—typically nonrecourse loans to severely distressed homeowners—will have a deep secondary market to pull liquidity back into the housing market. This seems far-fetched given that these assets have little or no yield and will have high default rates with no recourse. However, reading further, it appears that the proposal assumes a Federal Deposit Insurance Corporation (FDIC) insurance wrap for these assets to facilitate their sale. The cost of this insurance would likely be expensive and require a controversial new program, with premiums expected to cover losses or a congressional appropriation. However, it also ignores the fact that FDIC-insured depository institutions only hold about 25 percent of all mortgages.

Principal forbearance can be a useful loss-mitigation tool, although its value depends on economic circumstances. The 60/40 Plan that Professor Santos advocates is an example of principal forbearance and not a novel concept. Moreover, the 60/40 Plan does not consider a number of important institutional factors that have hampered loss-mitigation activities since the onset of the mortgage foreclosure crisis. Simply put, the 60/40 Plan will not save the housing market.

Scott Frame By Scott Frame, financial economist and senior policy adviser, and



Kris Gerardi Kris Gerardi, financial economist and associate policy adviser at the Federal Reserve Bank of Atlanta

March 9, 2011

The seductive but flawed logic of principal reduction

The idea that a program to reduce principal balances on mortgage loans will cure the nation’s housing ills at little or no cost has been kicking around since the very early stages of the foreclosure crisis and refuses to die. If news stories are true, the administration, in conjunction with the state attorneys general, will soon announce that lenders have agreed to write down borrower principal balances by a grand total of $20–$25 billion as part of a deal to address serious procedural problems in foreclosure filings. Policy wonks and housing experts will greet this announcement with glee, saying that policymakers have ignored principal reduction for too long but have seen the light and are finally going to cure the epidemic of foreclosures that has gripped the country since 2007. Are the wonks right? In short: we think not.

Why do so many wonks love principal reduction? Because they think principal reduction prevents foreclosures at no cost to anyone—not taxpayers, not banks, not shareholders, not borrowers. It is the quintessential win-win or even win-win-win solution. The logic of principal reduction is that in a foreclosure, a lender recovers at most the value of the house in question and typically far less. This is because of the protracted foreclosure process during which the house deteriorates and the lender collects no interest but has to pay lawyers and other staff to navigate 50 different byzantine state bureaucracies to get a clean title to the house, which it then has to sell in an extremely weak market. In contrast, reducing the principal balance to equal the value of the house guarantees the lender at least the value of the house because the borrower now has positive equity and research shows that borrowers with positive equity don’t default. To put numbers on this story, suppose the borrower owes $150,000 on a $100,000 house. If the lender forecloses, let's assume it collects, after paying the lawyers and the damage on the house, etc., $50,000. However, if it writes principal down to $95,000, it will collect $95,000 because the borrower now has positive equity and won't default on the mortgage. Lenders could reduce principal and increase profits!

The problem with the principal reduction argument is that it hinges on a crucial assumption: that all borrowers with negative equity will default on their mortgages. To understand why this assumption is crucial to the argument, suppose there are two borrowers who owe $150,000 but one prefers not to default (perhaps because she has a particularly strong preference for her current home, or because she does not want to destroy her

credit, or because she thinks there's a chance that house prices will recover) and eventually repays the whole amount while the other defaults. If the lender writes down both loans, it will collect $190,000 ($95,000 from each borrower). If the lender does nothing, it will eventually foreclose on one and collect $50,000, but it will recover the full $150,000 from the other borrower, thus collecting $200,000 overall. Hence, in this simple example, the lender will obtain more money by choosing to forgo principal reduction.

The obvious response is that the optimal policy should be to offer principal reduction to one borrower and not the other. However, this logic presumes that the lender can perfectly identify the borrower who will pay and the borrower who won't. Given that there is a $55,000 principal reduction at stake here, the borrower who intends to repay has a strong incentive to make him- or herself look like the borrower who won't!

This is an oft-encountered problem in the arena of public policy. Planners often have a preventative remedy that they have to implement before they know who will actually need the assistance. This inability to identify the individuals in need always raises the cost of the remedy, sometimes dramatically so. A nice illustration of this problem can be seen in the National Highway Traffic Safety Administration's (NHTSA) proposed regulation to require all cars to have backup cameras to prevent drivers from running over people when they drive in reverse. Hi-tech electronics mean that such cameras cost comparatively little: $159 to $203 for cars without a pre-existing navigation screen, and $53 to $88 for cars with a screen, according to the NHTSA. $200 seems like an awfully small price to pay to prevent gruesome accidents that are often fatal and typically involve small children and senior citizens. But the NHTSA says that the cameras are actually extremely expensive, and arguably prohibitively so. What gives? How can $200 be considered a lot of money in this context? The problem is that backup fatalities are extremely rare, something on the order of 300 per year, so the vast majority of backup cameras never prevent a fatality. To assess the true cost, one has to take into account the fact that for every one camera that prevents a fatality, hundreds of thousands will not. Done right, the NHTSA estimates the cost of the cameras between $11.3 and $72.2 million per life saved.

Some background
The idea of principal reduction starts with a correct premise: borrowers with positive equity—that is, houses worth more than the unpaid principal balance on their mortgages—rarely ever lose their homes to foreclosure. In the event of an unexpected problem (like an unemployment spell) that makes the mortgage unaffordable, borrowers with positive equity can profitably sell their house rather than default. The reason that foreclosures are rare in normal times is that house prices usually increase over time (inflation alone keeps them growing even if they are flat in real terms) so almost everyone has positive equity. What happened in 2006 is that house prices collapsed and millions of homeowners found themselves with negative equity. Many who got sick or lost their jobs were thus unable to sell profitably.

With this idea in mind, it then follows that if we could somehow get everyone back into positive-equity territory, then we could end the foreclosure crisis. To do that, we either need to inflate house prices, which is difficult to do and probably a bad idea anyway, or reduce the principal mortgage balances for negative-equity borrowers. So we have a cure for the foreclosure crisis: if we can get lenders to write down principal to give all Americans positive equity in their homes, the housing crisis would be over. Of course, the question becomes, who will pay? Estimates suggest that borrowers with negative equity owe almost a trillion dollars more than their homes are worth, and a trillion dollars, even now, is real money. The principal reduction idea might stop here—an effective but unaffordable plan—but people then realized that counting all the balance reduction as a cost was wrong. Furthermore, in fact, not only was the cost far less than a trillion dollars, but, as we noted above, many principal reduction proponents argue that it might not cost anything at all.

The logic that principal reduction can prevent foreclosures at no cost is compelling and seductive, and proposals to encourage principal reduction were common early in the foreclosure crisis. In a March 2008 speech, one of our bosses, Eric Rosengren, noted that "shared appreciation" arrangements had been offered as a way to reduce foreclosures; these arrangements had the lender reduce principal in return for a portion of future price gains realized on the house. In July 2008, Congress passed the Housing and Economic Recovery Act of 2008, which created Hope for Homeowners, a program that offered government support for new loans to borrowers if the lender was willing to write down principal.

While we were initially supportive of principal-reduction plans, we began to have doubts over the course of 2008. Our reasons were twofold. First, we could find no evidence that any lender was actually reducing principal. Commentators blamed the lack of reductions on legal issues related to mortgage securitization, but we became skeptical of this argument, because the incidence of principal reduction was so low that it was clear that securitization alone could not be the only problem or even a major one, (Subsequent research has shown this to be largely right: the effect of securitization on renegotiation was between nil and small in this crisis, and lenders did not reduce principal much even during the Depression, when securitization did not exist.) And the second issue, of course, was our realization of the logical flaw described above.

Negative equity and foreclosure
But aren't we being pessimistic here? Aren’t we ignoring research that shows that negative equity is the best predictor of foreclosure? No, we aren't. On the contrary, we have authored some of that research and have long argued for the central importance of negative equity in forecasting foreclosures. But what research shows is not that all or most people with negative equity will lose their homes but rather that while people with negative equity are much more likely to lose their homes, most eventually pay off their mortgages. The relationship of negative equity to foreclosure is akin to that of cholesterol and heart attacks: high cholesterol dramatically increases the odds of a heart attack, but the vast majority of people with high cholesterol do not have heart attacks any time in the near or even not-so-near future.

To be sure, there are some mortgages out there with very high foreclosure likelihood: loans made to borrowers with problematic credit and no equity to begin with, located in places where prices have fallen 60 percent or more. However, such loans are quite rare now—most of those defaulted soon after prices started to fall in 2007—and make up a small fraction of the pool of troubled loans currently at risk. To add to the problem, the principal reductions required to give such borrowers positive equity are so large that the $20–25 billion figure discussed for the new program would prevent at most tens of thousands of foreclosures and make only a small dent in the national problem.

Millions of borrowers with negative equity will default, but there are many millions more who will continue to make payments on their mortgages, behavior that is not, contrary to popular belief, a violation of economic theory. Economic theory only says that borrowers with positive equity won’t default (read it carefully). It is logically false to infer from this prediction that all borrowers with negative equity will default. "A implies B" does not mean that "not A" implies "not B," as any high school math student can explain. And in fact, standard models show that the optimal default threshold occurs at a price level below and often significantly below the unpaid principal balance on the mortgage.

The problem of asymmetric information
Ultimately the reason principal reduction doesn't work is what economists call asymmetric information: only the borrowers have all the information about whether they really can or want to repay their mortgages, information that lenders don’t have access to. If lenders weren't faced with this asymmetric information problem—if they really knew exactly who was going to default and who wasn't—all foreclosures could be profitably prevented using principal reduction. In that sense, foreclosure is always inefficient—with perfect information, we could make everyone better off. But that sort of inefficiency is exactly what theory predicts with asymmetric information.

And, in all this discussion, we have ignored the fact that borrowers can often control the variables that lenders use to try to narrow down the pool of borrowers that will likely default. For example, most of the current mortgage modification programs (like the Home Affordable Modification Program, or HAMP) require borrowers to have missed a certain number of mortgage payments (usually two) in order to qualify. This is a reasonable requirement since we would like to focus assistance on troubled borrowers need help. But it is quite easy to purposefully miss a couple of mortgage payments, and it might be a very desirable thing to do if it means qualifying for a generous concession from the lender such as a reduction in the principal balance of the mortgage.

Economists are usually ridiculed for spinning theories based on unrealistic assumptions about the world, but in this case, it is the economists (us) who are trying to be realistic. The argument for principal reduction depends on superhuman levels of foresight among lenders as well as honest behavior by the borrowers who are not in need of assistance. Thus far, the minimal success of broad-based modification programs like HAMP should make us think twice about the validity of these assumptions. There are likely good reasons for the lack of principal reduction efforts on the part of lenders thus far in this crisis that are related to the above discussion, so the claim that such efforts constitute a win-win solution should, at the very least, be met with a healthy dose of skepticism by policymakers.

Photo of Chris FooteChris Foote
Senior economist and policy adviser at the Boston Fed

Photo of Kris GerardiKris Gerardi
Research economist and assistant policy adviser at the Federal Reserve Bank of Atlanta

Photo of Paul WillenPaul Willen
Research economist and policy adviser at the Boston Fed

December 21, 2010

Revisiting real estate revisionism: Concessionary mortgage modifications during the Depression

During the current foreclosure crisis, lenders have seemed far more willing to foreclose on delinquent borrowers rather than offer them loan modifications. Some commentators have argued that this was not always the case. They claim that loan modifications are infrequent today because so many loans have been securitized, and thus are not owned by any one person or firm. They also say that the modern securitization process reduces loan modifications because securitization separates the entity that makes the modification decision—that is, the mortgage servicer—from the entities that gain the most if a foreclosure is avoided—that is, the mortgage investors. As we pointed out in our last post, Yale economist John Geanakoplos and Boston University law professor Susan Koniak argued in a March 2008 New York Times op-ed that the uncomplicated relationship between banks and borrowers in the good old days allowed the banks to work out modifications when their borrowers ran into trouble.

The Congressional Oversight Panel, created by Congress in October 2008 to "review the current state of financial markets and the regulatory system," expressed a similar belief in a March 2009 report on the state of the U.S. housing market:

For decades, lenders in this circumstance [that is, with troubled borrowers] could negotiate with can-pay borrowers to maximize the value of the loan for the lender (100 percent of the market value) and for the homeowner (a sustainable mortgage that lets the family stay in the home). Because the lender held the mortgage and bore all the loss if the family couldn't pay, it had every incentive to work something out if a repayment was possible.

Even in the good old days, lenders reluctant to restructure
Such claims, however, have usually been made with little or no reference to supporting research. Fortunately, a recent paper by Andra Ghent of Baruch College exploits a new data set to shed considerable light on this topic. Her findings argue against the idea that lender reluctance to modify is a recent phenomenon.

Ghent uses a data set from the National Bureau of Economic Research (NBER) that covers mortgages from 1920 to 1939, a period that encompasses the massive housing turmoil of the Great Depression. The data set consists of "mortgage experience cards," which the NBER collected in the 1940s from mortgage lenders in the New York metropolitan area. On the cards are the answers to short questionnaires about the characteristics of individual mortgage loans (see page 5 of Ghent's paper for an example). The cards also contain explicit information about any loan modifications, including the date of the modification and whether it was principal reduction, interest-rate reduction, change to the amortization schedule, or something else. The cards include loans from three types of mortgage lenders: life insurance companies, savings and loans, and commercial banks.1

Ghent finds few modifications in these cards, and these few were not particularly generous. Using a fairly conservative definition of what constitutes a concessionary modification, Ghent finds that approximately 5 percent of loans originated between 1920 and 1939 were modified, while 14 percent were terminated by foreclosure or a deed-in-lieu of foreclosure (the latter occurs when the owner surrenders the house to the lender without going through the foreclosure process). Of the loans that received a concessionary modification, about 40 percent received an interest rate reduction, which Ghent defines as an interest rate cut of at least 25 basis points (relative to origination) resulting in a new rate that is at least two standard deviations below the average interest rate on newly originated loans. The average rate reduction was only 78 basis points below the prevailing interest rate of new originations, suggesting that interest rate cuts were not particularly generous.

Another 40 percent of the modified loans received reductions in their amortization schedules, which would have likely decreased the required mortgage payments. However, Ghent points out that most of these extended amortizations occurred before 1930. In the period 1930–32, when house prices fell and unemployment rose the most, this type of modification was rare.

Principal balance reductions—and increases
Ghent also finds that less than 2 percent of all loans received principal balance increases. She argues that such increases may correspond to instances of forbearance. Forbearance occurs when a lender reduces the required mortgage payment for a short period. At the end of the period, the lender adds the arrears back to the loan balance. We have a minor quibble on this point: today, forbearance is not considered a permanent concessionary modification when the lender does not have to write down any debt.

What about principal reductions? Perhaps the most surprising finding is that the data set shows no instances of principal reduction in the New York City metropolitan area and only a handful of instances in a broader sample that includes the entire states of Connecticut, New Jersey, and New York over a similar period. To us, this low number of principal reductions is compelling evidence that even Depression-era lenders were averse to renegotiating with troubled borrowers, just as lenders are today.

Balloon mortgages sank some borrowers
Another interesting finding concerns the refinancing decisions of lenders. Short-term balloon mortgages were more common in the 1920s and 1930s than they are today, and various scholars have linked the high foreclosure rate of the Depression to the unwillingness of lenders to refinance these mortgages when they came due. In fact, lender reluctance to refinance maturing mortgages is often used to explain the existence of the Home Owners' Loan Corporation (HOLC), a government organization set up in the early 1930s to refinance troubled mortgages. Ghent revisits this hypothesis with her data, measuring the frequency at which short-term balloon mortgages ended in foreclosure. She finds that balloon mortgages that were about to expire did indeed experience increased rates of foreclosure (see Ghent's table 4). However, this relationship only exists during the years when HOLC was purchasing a great many loans (1933–35). In other years, balloon mortgages were no more likely to end in foreclosure than other loans.

To us, this finding suggests a "HOLC effect." While HOLC was actively buying loans, private lenders may have refused to roll them over so that the borrowers would qualify for a HOLC refinance. If they did, then the lenders would be paid close to par for the loans by the government (see our previous post about the generosity of the HOLC program). In particular, the lenders received what were effectively government bonds in return for their mortgage. While these bonds carried lower interest rates, they carried vastly less credit risk as well.

To explain her findings, Ghent points to information problems between borrowers and lenders. In particular, lenders may not have known which borrowers were likely to truly need modifications, nor did they know with certainty which borrowers were likely to re-default if a modification were offered. Note that these information problems must have been quite severe. The national unemployment rate hit 10.8 percent in November 1930 and stayed in double digits for more than a decade. In this environment, a borrower asking for a modification was quite likely to really need one. The fact that lenders made few modifications suggests some strong intrinsic hurdles to renegotiation when information between borrowers and lenders is less than perfect.

Old problems, new analysis
The crucial policy question is what the Depression-era reluctance of lenders to renegotiate teaches us about today's foreclosure crisis. Ghent surmises that the information problems are less of an issue in the current environment, but we disagree. Even with better data and screening technology, today's lenders face significant information problems when deciding on modifications. Moreover, Ghent's paper is also informative on the role of securitization in reducing modifications. Even when individual lenders owned entire loans, modifications were rare.

All told, Ghent's paper is full of solid analysis on a topical subject. And while she doesn't quite go this far, we believe that her findings not only confirm the importance of information problems, but also they may bury the notion that securitization is the primary obstacle to renegotiation in the current foreclosure crisis.

Photo of Kris GerardiKris Gerardi
Research economist and assistant policy adviser at the Federal Reserve Bank of Atlanta

 

Photo of Chris Foote Chris Foote, senior economist and policy adviser at the Federal Reserve Bank of Boston

 

1 Ghent argues that the data set probably provides a representative sample of loans held by life insurance companies and commercial banks in the 1920s and 1930s, but is less likely to be representative of loans held by savings and loans due to a survivorship bias. Unlike life insurance companies and commercial banks, savings and loans were not able to reliably report data on their inactive loans at the time of the survey.