Study Says That Foreclosure Ban May Worsen Financial Crisis

President-elect Barack Obama has called for a 90-day moratorium on foreclosures, but history warns that such measures can in fact worsen the overall crisis. For more on this, …

President-elect Barack Obama has called for a 90-day moratorium on foreclosures, but history warns that such measures can in fact worsen the overall crisis. For more on this, read the following article from Housing Wire.

As 2008 is increasingly compared to the 1930s, it appears the nation is playing ball in the same field as the nation’s greatest depression—scary, but true. A look back to the Great Depression offers evidence that imposing a temporary ban on foreclosures in response to the current financial havoc could impose unintended costs that should be weighed against potential benefits, according to an analysis released Tuesday by the Federal Reserve Bank of St. Louis.

Nearly one percent of U.S. home mortgages entered foreclosure during the first quarter of 2008, and nearly 2.5 percent of all home mortgages were in foreclosure by the end of the quarter.

But let’s back up to Jan. 1, 1934—the height of the Great Depression: As many as half of all urban home mortgages were delinquent. State and local governments at the time, responded to the increasing number of foreclosures by primarily changing laws. According to economist David Wheelock’s report, 27 states opted to temporarily halt foreclosures, while others enacted permanent changes that made it more difficult for lenders to foreclose on mortgaged properties.

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Wheelock noted that moratoria and other changes to mortgage laws favored borrowers over lenders, enhancing the rights of borrowers to withhold foreclosed property while limiting the rights of lenders to sue for deficiency.

“Foreclosure moratoria generally applied to both farm and nonfarm residential mortgages,” said Wheelock. “However, the pressure for foreclosure moratoria was particularly intense in Midwestern states where farm foreclosure rates were especially high.” Naturally, such regulations led to much lower farm foreclosure rates—but with a cost.

Governments cause both immediate and long-term effects when they rewrite the terms of contracts between private parties, Wheelock argued. “Although the economic and societal benefits of lower foreclosure rates are difficult to measure,” he said, “research shows that the foreclosure moratoria of the Great Depression imposed costs on future borrowers.”

Future borrowers were faced, according to the analysis and cited studies, with a restricted supply of loans and sky-high interest rates, because lenders needed to compensate for the possibility that their right to foreclose on delinquent loans would be constrained. Under the nation’s current turmoil, policymakers are scrambling to enact similar regulations as were made during the great depression, in order to limit the highest foreclosure rates since (what else?) the Great Depression.

Beginning on July 30, when President Bush signed into law the Housing and Economic Recovery Act, foreclosure prevention has been increasingly pushed, as loan modification plans and programs such as Hope for Homeowners have become increasingly common. Locales including Massachussetts and local cities have sought to put foreclosure moratoriums in place; federal legislators, too, have argued

While the nation is indeed in search of a quick fix, Wheelock warns against legislative actions to reduce foreclosures and foreclosure moratoria in particular, as it may inflict a big burden on borrowers in the long run.

This article has been reposted from HousingWire. View the article on Housing Wire’s mortgage finance news website here.

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