The Sinister Side of Foreclosure Prevention

 | Sep 17, 2011 | 2:30 PM EDT  | Comments
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Never since the Great Depression has high unemployment persisted for so long after the end of a recession as it has done today. In fact, employment in the U.S. is about 5% lower now than it was at the peak of the statistic when the recession began. That is far worse than in any post-World War II recession, including the deep recession of the early 1980s, which saw high unemployment recede relatively quickly in the ensuing recovery. Three years after that recession, the U.S. economy had about 3% more jobs than it did at its prerecession peak.  

There are a number of reasons why high unemployment has continued in this manner -- but, interestingly, one of these reasons appears to be mortgage modifications. That is the conclusion of research presented in a paper (PDF) by the National Bureau of Economic Research, the same organization charged with dating the beginning and ending of recession. Specifically, the Bureau has found that mortgage modifications have increased the unemployment rate by 0.5% and reduced real gross domestic product by 1% for several years after the modifications had been put in place. These numbers, then, reflect both lower employment and lower productivity.

Why is this so? Perhaps it might not come as too much of a surprise, given that various regions in the economy have experienced widely divergent rates of unemployment, while staying put in one's home reduces the ability and incentive to move and seek better employment opportunities. This is an essential factor in the issue of structural unemployment, which is that component of unemployment that likely won't be solved simply by increasing aggregate national demand. 

Additionally, because the loan modifications have payments that are tied to a homeowner's disposable-income levels, an increase in income would mean an increase in mortgage payments. This reduces the incentive to take a higher-paying job -- perhaps one that would improve his or her skills sets and increase productivity. It could, for that matter, discourage a person from taking any job, should they be receiving unemployment benefits.

The researchers build on earlier studies that show unemployment is higher in regions with higher homeownership rates precisely because the latter makes that segment of the economy less mobile. In fact, owning a home historically reduces mobility by 40% -- and having an underwater mortgage might make that mobility even lower. A mortgage modification, while making the payments more affordable, reduces the incentive to simply walk away from the home to pursue employment elsewhere. The researchers estimate that a 10% reduction in mortgage payments through a modification program amounts to an 11.3% reduction in the chances that someone will walk away from their home.

These longer periods of unemployment apply not only to the homeowners whose loans were modified, but also to all of the other unemployed people in the same region who are competing for those few available jobs. The research demonstrates that this induced lack of incentive to relocate for a job increases the duration of unemployment from 17.3 weeks -- in a model economy without mortgage modifications -- to 18.1 weeks.

In addition to this, as the research notes, an erosion of workers' skills results from a disincentive to work, or work at one's full capacity in a job that allows skills accrete in value. This phenomenon, and lack of mobility -- both geographical and career-wise -- causes a decline in productivity across this segment of the population, and that reduces the long-term growth potential of the economy. So, it isn't just an issue of the unemployed not finding jobs because they won't relocate. It's also a matter of the currently employed not seeking to advance their careers by moving to a different place.

So, are these loan modifications worth it? I suppose it depends on one's preference in a hypothetical situation where one is presented with only two choices. The first is an environment with higher unemployment, lower income and lower foreclosure rates, while the second is one with lower unemployment, higher income and higher foreclosure rates. Even then, the results of loan modifications are, in my opinion, underwhelming. Yes, the research demonstrates that loan modifications for an employed homeowner make for a 48% reduction in the chances he or she will walk away from the mortgage. However, many with modified mortgages end up defaulting again anyway.

In fact, the research shows that anywhere from 30% to 50% of those receiving a mortgage modification redefault on the modified mortgage within one year of its implementation. As such, these programs have reduced the foreclosure rate by just 0.2%. They have, however, reduced the number of renters, with that percentage of households falling from the 48% level -- in a model with no modifications -- to 38%. The research also shows that, due to factors already mentioned, higher homeownership rates are associated with reduced income across a long time period, and more than merely a few years.

In the hypothetical decision presented above, policymakers appear to have chosen a model of high homeownership rates and lowered foreclosures as a preferred outcome over a higher-income, lower-unemployment environment with a higher foreclosure rate. We have ample evidence that the government prefers a homeownership society. After all, the tax code even subsidizes the practice through the mortgage interest deduction. Unfortunately, however, that goal of encouraging people to stay in homes they could not otherwise afford -- instead of foreclosure or, even, merely renting to begin with -- has come to the detriment of our economic output and employment.

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