Post date: Feb 10, 2012 3:58:46 AM
The mortgage settlement has finally arrived: 5 banks that were charged with robo-signing foreclosure documents are now agreeing to pay $25 billion in soft money (a small fraction, $1.5b, will actually be cash payouts) to the mortgagors in all the states except Oklahoma. The settlement includes some small $1-2k payments for those wrongly foreclosed and promises principal write downs for those who are delinquent and have negative equity (but you can imagine there will be some other stricter criteria... hopefully). There are a couple issues with his:
According to my research, negative equity is NOT the true cause of defaults, job loss is a better predictor of default- so why pour good money after bad instead of funding small businesses or other projects with growth prospects
The incentive effects are too strong- we may be witnessing the perfect natural experiment... if Oklahoma doesn't enter the agreement, no one in Oklahoma should change their payment behavior. However, in the rest of the US, the settlement provides incentives for people with negative equity to skip payments and ask for a write-down. This is the perfect natural experiment- if the incentive effect is strong, we should see default hazard rates spike everywhere except Oklahoma. Anyone want to do this with me on the LPS data?
What about mobility! Lee and I have written extensively about mortgage modifications and people using their homes as unemployment insurance by skipping payments or asking for means-tested modifications (see our Cato Paper and our new paper on Foreclosure Delays, coming soon and recently presented at the Hoover Institute)
The long run damage- what bank is going to want to lend in a country where the rules of the game are shifting sands? Why would any bank start lending to young couples looking to purchase a home if they anticipate that in the future the government will attempt to alter the mortgage contract to give all the upside to the mortgagor and all the downside to the bank.
Key Question: Who will do the natural experiment first!?!