Foreclosure Prevention

My blog entry this week is on “Foreclosure Prevention.” The issues may be grouped around justice, contagion, and strategy. Discussions will be sorted as clusters develop. The series of three blog entries, in successive weeks, starts with strategy, continues with contagion and concludes with justice.

Starting with strategy, consider my essay, “Foreclosure? The Right Way to Play the Suit May be the Wrong Way to Play the Hand: A Strategic Approach to Averting a Crash in the Housing Market and its Fallout.” [Foreclosure Essay with a Strategic Approach.] The idea here comes in two major parts. The first is to avoid a crash in the local market of a subject property. The second is to avoid a cascading of local market housing crashes. At first glance, many people will consider both cases as being remote possibilities, especially the latter. As policy makers could wait until the possibilities seem less remote. The problem is that the longer the wait and the less remote the more difficult it becomes to avert. One could make mathematical calculations that would weigh the chances against the costs, but as with catastrophic events, even low probabilities are of little comfort if the catastrophe strikes. [Think Black Swan.]

Thus, prudent decision makers, when insurance policies are not available or realistic, may take preventive action even with probabilities not favoring the odds of caution. The ego-for-broker's strategy takes the chance. The Minimax strategy constrains the level of risk and maximizes within those constraints. In order to develop such a strategy it is essential to work with local data that identifies the high risk areas. The discussion which follows is a first step in developing such a strategy, cascading, is more difficult to tackle because of the problem of identifying tipping points before they happen. Forecasters do well in extrapolating from the past, but the turning points may arise in different patterns because of differences in people's responses, among other things. It may be a case of emergencie's. The link to the essay and a follow-up item is as follows: Foreclosure Essay with a Strategic Approach

As an interim reading the blog originally planned was longer than the 300 to 500 size I was advised to use, so I have sliced it up for a series of entries. The link to a long version designed for slicing is as follows: Foreclosure Prevention.


Foreclosure Prevention - Comment by Bob Edelstein

Here is an excerpt from study “The Housing Problem and the Economic Crisis: A Review and Evaluation of Policy Prescriptions. It consists of the Concluding Remarks and Remaining Issues.” This is the excerpt: A confluence of macroeconomic, social and financial forces caused the housing and subprime bubbles in the US. Macroeconomic conditions provided several crucial elements. US consumer debt fueled the trade deficit, which was financed substantially with savings by US trading partners. These global imbalances and capital inflows combined with official Fed interest rate policy (in response to the dot com bust and the recession of 2002) generated cheap and plentiful debt. There was copious, cheap mortgage money for homebuyers at one end, and a willing pool of global investors in securitized mortgages, at the other, all lubricated by lax oversight and weak regulation.
New borrowers emerged to meet the expanding supply of mortgage money. Homeownership rates rose among younger and lower income households. The financial sector frenetically expanded products to serve the demand from homeowners and satisfy yield starved investors. Through nothing short of financial alchemy, security issuers created derivatives with higher ratings than what the underlying securities could support. The fee structure rewarded lenders, mortgage brokers, rating agencies, and securitizers for originations rather than financial product viability, thereby creating incentives for increased transactions. Regulatory laxness passively permitted diluted underwriting standards and predatory lending practices, supporting the growth of subprime and Alt-A mortgages, which were then securitized and sold to investors around the world.

Subsequently, with lower growth in demand for homes, prices began to flatten or dip, and the boom in home construction collapsed. Simultaneously, the many subprime mortgages with interest reset provisions started to come due. Combined with lower sales activity and prices, a self-sustaining loop was created, causing marginal borrowers to default, further worsening housing market conditions. As home prices sank and mortgage default rates rose, the value of mortgage securities began to decline and the derivatives market started unraveling. The failure of major U.S. financial institutions, heavily invested in dodgy assets, and the repeated need for tens and then hundreds of billions of dollars in government provided funds to keep them afloat, led to a much broader financial crisis across all asset markets not only within the US but globally.

It is clear that the larger financial and economic crisis cannot be resolved without stabilizing and addressing key issues surrounding the housing market, in general and foreclosures in particular. A solution to the mortgage/home price/foreclosure problems will likely engender stabilizing forces for other critical sectors of the economy. In this paper, we evaluate all the major, existing housing and mortgage related policy proposals, while applying our benchmark criteria of i) future mitigation of moral hazard, ii) bang for the buck, iii) fairness and distributive aspects, and iv) judicious mix of short-term and long term solutions. Going forward, several factors will be important for fostering stability in the housing and residential finance markets:

1. A sustainable, viable plan is likely to require elements of a standardized approach (e.g. for interest rate reduction), as well as triage for case-by-case loan modifications.

2. Losses and gains may have to be shared among three parties: lenders, borrowers and Government.

3. Legal reform may be necessary in order to delink servicers from security investors and clear the way for refinancing.

4. Targeting home-buying assistance to geographic areas with high foreclosure rates would bring the support directly to neighborhoods most in need of housing market stabilization.

5. There is little data on “jingle mail” share of foreclosures and on investor-landlords. A method for addressing these homes, perhaps tied to rental assistance, could keep the homes occupied and off the market.

6. An overhaul, restructuring and redistribution of federal and state regulatory responsibilities might combine the best institutional features of both.

The full report is on the Hoyt website

Posted by Maury Seldin on behalf of Bob Edelstein,Co-Chair of the Fisher Center for Real Estate and Urban Economics at the Haas School of Business, University of California Berkeley.

Liberty without Law: Financial Chaos - Paul Carr


The discontinuities in the complexity versus uncertainty figure can be attributed to non linear phase transitions and the Matthew Effect, "to him who has more shall be given." This is similar to Shermer's "Cumulative advantage and best seller effects."

Should laissez-faire economics be regulated? Too much liberty can degenerate into unaccountable chaos. Thaler & Sunstein (2008) argue that totally free markets can lead to disasters precisely because autonomous individuals are not good decision-makers. Too little liberty may cause stagnation. What is an optimum balance between autonomy and heteronomy (law) ?

Peters (2001) and Shermer ((2009) build on Adam Smith's invisible hand and chaos/complexity theory to show how free markets are by their nature continually evolving, emerging systems that require uncertainty to operate successfully. Let us apply this to the gross domestic product (GDP). Counties with too much regulation, control, and law (such as the USSR and China before 1989) had a low GDP. At this time, Europe and the US had a high GDP, indicating an optimum mix of law and liberty to innovate. In countries without enough law, i.e. anarchy, like Zimbabawe, the GDP was again low. Trust and the Matthew Effect (Shermer) contribute to maximizing the GDP.

Freedom decreases as the price of oil increases. (Friedman's (2008) Law of Petropolitics).

Alan Greenspan, when asked about the present financial crisis, said he had “overestimated the correcting power of free markets.” The delicate balance between law and liberty had been tilted too much toward the latter.
“Confirm thy soul with self control, thy liberty with law.” (Bates 1895 “America The Beautiful”).

Friedman, Thomas. 2008 Hot, Flat, and Crowded,

Peters, Edgar, E. 2001, Complexity, Risk, and Financial Markets, Wiley

Shermer, Michael, 2009. The Mind of the Market: How Biology and Psychology Shape Our Economic Lives, Holt Paperbacks.

Thaler, Richard, Sunstein, Cass. 2008. Nudge:Improving Decisions about Health, Wealth, Happiness


Posted by Maury Seldin on behalf of Paul H. Carr, AF Research Laboratory Emeritus