Doing Foreclosure the Right Way
Millions of homes have gone through foreclosure since the housing market peaked about seven years ago, mainly in the Sunbelt bubble states. According to Bloomberg News, New Jersey is now the state with the greatest share of mortgages either delinquent or in foreclosure, while New York is in third. (Florida is No. 2.)
Yet New Jersey and New York might provide lessons for how to cope with the market disruption of foreclosure. Their rise in their foreclosure rates probably reflects the more methodical approach both states use to seize a home, rather than a weakening of the local economy.
When it comes to foreclosures, U.S. states come in two flavors: those that make it quick and those that require a judge's approval. The process is fast in Nevada, California and Arizona but slow in states such as New York, New Jersey and Florida, where a foreclosure takes about 1,000 days, on average. Those latter three states happen to have the greatest share of mortgages either seriously delinquent or in foreclosure.
You might think that a speedy foreclosure process is better than a slow one. Economies function best when assets are owned by the people who can use them most productively. So in principle, a legal system that gets delinquent borrowers out of their homes and sells those homes to new owners as quickly as possible ought to be better than one where rules slow things down. Dallas and Denver are two of the most vibrant housing markets in the U.S. and both are in so-called "non-judicial" states. Arizona and California now have the some of the lowest mortgage delinquency rates in the country. (Nevadans have made a lot of progress reducing their debt burdens but are still among the most delinquent borrowers in the U.S.)
Quick foreclosures may make sense when home values are rising and the economy is growing, but there is good reason to think that the expedited process actually made things worse during the housing bust. In a clever study, economists Atif Mian, Amir Sufi and Francesco Trebbi focused on communities that were split across borders of judicial and non-judicial foreclosure states. (Think of Kansas City, which straddles Missouri and Kansas, or the Quad Cities, which are centered on the border between Iowa and Illinois.) During the boom, housing prices, residential construction and consumer spending behaved similarly across state lines.
Once prices started falling, however, the people who lived on the non-judicial side of the border fared much worse. The reason, according to the economists, is that the rapidity of the foreclosure process created a glut of homes available for sale. That crushed prices, which made everyone else poorer. Borrowers with low credit scores and homes worth less than their mortgage balance concluded that they should walk away from their obligations, which further increased the supply of housing and depressed home values even more.
In general, the places that slowed this process ended up doing better than those that didn't, presumably because they curtailed the sharp decline in house prices and bought people time to wait for the economy to recover. Maybe next time around we'll remember that.
(Matthew C. Klein is a writer for Bloomberg View. Follow him on Twitter.)
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