The paper examines and refutes the argument long used by experts that mortgage foreclosures greatly reduce the sale prices of properties in the area. The Atlanta researchers approached the issue using a new dataset that takes into account the stage of the foreclosure process on a property and the property’s condition.
The Atlanta Fed’s paper includes research on mortgage loans that are seriously delinquent, as well as REOs and the number of properties recently sold by the lender. The study also includes minor delinquencies, defined by the researchers as delinquencies less than 90 days.
This more open approach allows for the possibility that the foreclosure externality (the effect of the foreclosure on neighboring properties) might occur before the process is actually completed.
The study actually found while neighboring home prices do tend to sink when a property becomes distressed, the effect is only minor. Furthermore, the effect appears when the borrower first becomes seriously delinquent on the loan and disappears approximately one year after the foreclosure is sold.
Because foreclosure externalities peak before the process is completed, the Atlanta Fed concluded that issuing a foreclosure moratorium would do nothing but draw out the delinquency period, making the problem worse.
“Our results suggest that they key to minimizing the costs of foreclosure is to minimize the time that properties spend in serious delinquency and in REO. On one hand, this implies putting pressure on lenders to sell properties out of REO quickly. On the other hand, and perhaps much less palatably, it implies minimizing the time a borrower spends in serious delinquency, which means accelerating the foreclosure process,” the paper read.
The paper argues that the likely explanation for the drop in surrounding home prices is the “investment externality effect,” or the tendency of borrower and lenders underinvesting in property maintenance because they have nothing to gain from a distressed or foreclosed property. As a result, the home falls into disrepair, and nearby prices suffer.
The researchers also debate against the possible explanation that an increasing supply of houses on the market (boosted by foreclosures) could give buyers more bargaining power:
“If we thought foreclosed properties were driving down prices by competing with non-distressed sales, then we would expect, at the very least, that the properties in above average condition would have the same effect as properties in below average condition and, indeed, we might even expect the above- average properties to generate even more competition,” the paper read.
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