Christopher L. Foote

Negative Equity and Foreclosure: Theory and Evidence

Recent declines in housing prices have focused attention on the relationship between negative housing equity and mortgage default. Theory implies that negative equity is a necessary condition for default, but not a sufficient one. This often-misunderstood result is clearly illustrated in a dataset of Massachusetts homeowners during the early 1990s; fewer than 10 percent of borrowers likely to have had negative equity at the end of 1991 experienced a foreclosure during the following three years. An econometric model of default estimated on two decades of Massachusetts housing data also predicts low default rates for current negative-equity borrowers. We develop a simple theoretical model to interpret these empirical findings and to assess potential foreclosure-reduction policies. Our results imply that lenders and policymakers face an information problem in trying to help borrowers with negative equity, because it is hard to determine which owners really need help in order to stay in their homes.

Reducing Foreclosures: No Easy Answers

This paper takes a skeptical look at a leading argument about what is causing the foreclosure crisis and what should be done to stop it. We use an economic model to focus on two key decisions: the borrowers choice to default on a mortgage and the lenders subsequent choice whether to renegotiate or modify the loan. The theoretical model and econometric analysis illustrate that unaffordable loans, defined as those with high mortgage payments relative to income at origination, are unlikely to be the main reason that borrowers decide to default. In addition, this paper provides theoretical results and empirical evidence supporting the hypothesis that the efficiency of foreclosure for investors is a more plausible explanation for the low number of modifications to date than contract frictions related to securitization agreements between servicers and investors. While investors might be foreclosing when it would be socially efficient to modify, there is little evidence to suggest they are acting against their own interests when they do so. An important implication of our analysis is that policies designed to reduce foreclosures should focus on ameliorating the immediate effects of job loss and other adverse life events rather than modifying loans to make them more affordable on a long-term basis.

Why did so many people make so many ex post bad decisions?: the causes of the foreclosure crisis

We present 12 facts about the mortgage crisis. We argue that the facts refute the popular story that the crisis resulted from finance industry insiders deceiving uninformed mortgage borrowers and investors. Instead, we argue that borrowers and investors made decisions that were rational and logical given their ex post overly optimistic beliefs about house prices. We then show that neither institutional features of the mortgage market nor financial innovations are any more likely to explain those distorted beliefs than they are to explain the Dutch tulip bubble 400 years ago. Economists should acknowledge the limits of our understanding of asset price bubbles and design policies accordingly.

Subprime Facts: What (We Think) We Know about the Subprime Crisis and What We Don't

Using a variety of datasets, we document some basic facts about the current subprime crisis. Many of these facts are applicable to the crisis at a national level, while some illustrate problems relevant only to Massachusetts and New England. We conclude by discussing some outstanding questions about which the data, we believe, are not yet conclusive.

Testing Economic Hypotheses with State-Level Data: A Comment on Donohue and Levitt (2001)

State‐level data are often used in the empirical research of both macroeconomists and microeconomists. Using data that follows states over time allows economists to hold constant a host of potentially confounding factors that might contaminate an assignment of cause and effect. A good example is a fascinating paper by Donohue and Levitt (2001, henceforth DL), which purports to show that hypothetical individuals resulting from aborted fetuses, had they been born and developed into youths, would have been more likely to commit crimes than youths resulting from fetuses carried to term. We revisit that paper, showing that the actual implementation of DL’s statistical test in their paper differed from what was described. (Specifically, controls for state‐year effects were left out of their regression model. ) We show that when DL’s key test is run as described and augmented with state‐level population data, evidence for higher per capita criminal propensities among the youths who would have developed, had they not been aborted as fetuses, vanishes. Two lessons for empirical researchers are, first, that controls may impact results in ways that are hard to predict, and second, that these controls are probably not powerful enough to compensate for the omission of a key variable in the regression model. (Data and programs to support this comment are available on the web site of the Federal Reserve Bank of Boston.)

Space and Time in Macroeconomic Panel Data: Young Workers and State-Level Unemployment Revisited

A provocative paper by Shimer (2001) finds that state-level youth shares and unemployment rates are negatively correlated, in contrast to conventional assumptions about demographic effects on labor markets. This paper updates Shimers regressions and shows that this surprising correlation essentially disappears when the end of the sample period is extended from 1996 to 2005. This shift does not occur because of a change in the underlying economy during the past decade. Rather, the presence of a cross-sectional (that is, spatial) correlation in the state-level data sharply reduces the precision of the earlier estimates, so that the true standard errors are several times larger than those originally reported. Using a longer sample period and some controls for spatial correlation in the regression, point estimates for the youth-share effect on unemployment are positive and close to what a conventional model would imply. Unfortunately, the standard errors remain very large. The difficulty of obtaining precise estimates with these data illustrates a potential pitfall in the use of regional panel data for macroeconomic analysis.

Arbitraging a Discriminatory Labor Market: Black Workers at the Ford Motor Company, 1918–1947

The 1918–47 employee records of the Ford Motor Company provide a rare opportunity to study a firm willing to hire black workers when similar firms would not. The evidence suggests that Ford did profit from discrimination elsewhere, but not by paying blacks less than whites. An apparent “wage‐equity constraint” prevailed, resulting in virtually no racial variation in wages inside Ford. An implication was that blacks quit Ford jobs less often than whites, holding working conditions constant. Arbitrage profit came from exploiting this nonwage margin, as Ford placed blacks in hot, dangerous foundry jobs where quit rates were generally high.

subprime mortgage crisis, the

A subprime mortgage loan is a residential mortgage loan that is particularly risky for some reason. The elevated risk may stem from the credit history of the borrower, the lack of a large down payment, or a monthly payment that is large relative to the borrower’s income (see Chapter 2 of Muolo and Padilla (2010) for a history of subprime residential lending). Subprime loans were unlikely to meet the credit-quality standards of the two government-sponsored entities (GSEs), Fannie Mae and Freddie Mac, which package so-called prime mortgage loans into mortgage-backed securities for sale to outside investors, and which eliminate credit risk by guaranteeing principal and interest payments to investors if the borrower defaults. While the GSEs did not have hard-and-fast cutoffs regarding borrower credit quality, they were historically less likely to securi-tize loans made to borrowers with poor credit histories.