Essays on Government Policy and Household Financial Decisions

Author: Karen Pence

Dissertation School: University of Wisconsin-Madison

Abstract:

When a borrower defaults on his or her home mortgage, the lender may attempt to recoup the losses by repossessing and selling the house. This process, called a foreclosure, is governed by state laws. Some states’ foreclosure laws impose sizeable costs on lenders, while other state laws are relatively inexpensive. These costs, which include legal fees, foregone interest, and property expenses such as maintenance and taxes, can be quite large: Clauretie and Herzog (1990), for example, found that the average loss on FHA loans terminated in 1984 was 45 percent of the average mortgage balance.

My dissertation investigates the effect of foreclosure laws on the supply of loans, a topic that provides insight into HUD’s "Issues in housing finance" and "Homeownership" research themes. State foreclosure laws affect the efficiency of the mortgage lending market if households are harmed by restricted borrowing options more than they are helped by the law’s protections. The laws may also affect the solvency of FHA lending programs disproportionately, given historically higher FHA default rates. In addition, the laws may affect the ability of the housing finance system to attain other social goals such as increasing the rates of home-ownership and serving low-income and racial minority borrowers effectively. When loan supply is reduced, some households will not be able to purchase homes. These households are likely to be borrowers whose home-buying options are already limited – a group that is predominantly low-income and minority.

Although foreclosure laws influence many aspects of the housing market, surprisingly little research has examined their effects. This neglect stems in part from data limitations: almost no data sets have the geographic scope and the detailed characteristics needed to estimate the laws’ effects. In this research, I create a unique data set that contains information on borrowers, their neighborhoods, and the foreclosure laws in their state. Using this data set, I control for additional unobserved variables through a "borders" estimation technique that exploits the spatial relationships between the census tracts in the data set. This technique compares loan applications that are geographically close to each other yet are located in different states, implicitly assuming that many unobserved factors vary with location. Thus, I can use the sharp change in policy regimes at the border to identify the effect of foreclosure laws while also controlling for variables that are unobserved on the data set. The measures of decreased loan supply – including loan size, the probability that an application is rejected, and rates of homeownership – are motivated from a simple analytic framework.

HUD’s National Homeownership Strategy (1995) identified "Home Mortgage Foreclosure Requirements" as one of 100 actions targeted to increase the rates of homeownership. The policy simulations produced by this dissertation will highlight foreclosure law reforms that may increase homeownership, as well as improve the efficiency and equity of the housing finance system.

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