Foreclosure Contagion

How badly does a foreclosed home hurt its neighbors?

The Center for Responsible Lending says this effect is quite sizable and that all told, 41 million properties across the country are vulnerable to the foreclosure contagion. The resulting devaluation would be in the $200 billion range.

For this reason, Congress has been trying to pass a bill that would stem the tide of foreclosures, expected to be somewhere in the one to two million range. It doesn't make sense that households which can afford their mortgage payments -- or already fully own their homes -- should be punished for their neighbors' misfortunes or bad money management. After all, the home buying process doesn't include credit checks on neighbors.

But using repeat sales and foreclosure data from 1989 to 2007 for 140 communities nationwide, John Harding of the Univ. of Connecticut and Eric Rosenblatt and Vincent Yao of Fannie Mae argue that the 41 million figure is overstated. The reason is that distance counts, and the further away a "good standing" home resides from a foreclosed one, the less the "good standing" home's value will depreciate.

The following chart from the paper shows this effect. Each colored line represents the distance between a foreclosed home and non-foreclosed one: pink is less than 300 feet, red is between 300 and 500 feet, blue is between 500 and 1000 feet, and purple is between 1000 and 2000 feet. (Click for larger)

So, if five homes within 300 feet of a "good standing" home are foreclosed on, then the "good standing" home will see a seven percent hit to its value. Between 300 and 500 feet, the negative hit is a little over five percent. Between 1000 and 2000 feet, the effect is closer to two percent.

The Center for Responsible relied on this study which found that homes within 1/8 of a mile will see their value decline by 0.9 percent when a nearby home forecloses. The big difference between the two studies is that the one used by the Center wasn't able to control for local housing market trends. The Harding, Rosenblatt, and Yao paper does and finds that within 1/8 of a mile, the depreciation is closer to 0.6 percent.

From a policy perspective, our results confirm the existence of a significant negative externality associated with foreclosed properties. However, our estimates of that externality controlling for the local trend in house prices are generally smaller than previous estimates and we provide evidence that the most significant externalities are attributable to immediate neighbors. As a result, a million additional foreclosures would significantly affect fewer than the forty million homes previously estimated.

The researchers also find that the negative hit from a foreclosure is strongest right before a lender takes control of the property. They argue "that when foreclosure is inevitable, efforts to speed the foreclosure process would be effective at reducing the contagion effect."

The current version of the billion housing bill doesn't have any provisions that deal with this problem, but the one part that comes close -- a provision giving $3.9 billion to communities to buy up distressed properties -- could derail the whole bill. The Philly Daily News put it best (emphasis mine):

President Bush had threatened to veto a $300- billion foreclosure-aid bill because $3.9 billion had been set aside for buying and rehabilitating foreclosed properties. Then when Fannie and Freddie faced a crisis, the irony-challenged administration asked for a blank check to back them up.

Comments

[CLH:]

There is little the gov can do to stop foreclosures. Foreclosurers are caused by prices going down and people walking away (which is the smart thing to do). If the house is now worth much less then you owe, you are a fool to not walk away and wait for the prices to come down.

Did you hold your margined internet stocks? Of course not. Quit feeling sorry for the smart people ---those who walk away.

The English in former times had a debters prison. This no longer exists.

2008 Jul 20 07:44 AM

[rm:]

I fail to see how Bush's objection to rehab handouts makes him "irony-challenged."

A "Foreclosure Prevention Act" should focus on preventing foreclosures, it would seem. Any "prevention" effect of this portion of the bill would be tangential at best... and that's a stretch.

I suppose there's nothing ironic in Barney Frank's recent backtracking on what this bill is designed to do, or Christopher Dodd's admissions that this measure won't be enough.

2008 Jul 20 08:21 AM

[msoori:]

Anything that the government would do is to bail out the big banks at the expense of the taxpayers. Government doesn't care about the poor families loosing their dream homes, just doing the lip service till the elections are over. In the mean time, educate yourself as to what your options are if you or some one you know are facing foreclosure. My site has links to foreclosure prevention info at http:\xmplary.net

2008 Jul 20 09:52 AM

[notsosmart:]

this administration & congress care about nothing & nobody(well-maybe wallst.).it may be too late but the country might not survive this downhill slide.the dc people care only for themselves.the dumb-dumber americans elected this guy2x & put almost the same jerks back in congress & then rate them 9% approval.if it wasnt so sad it would really be funny.

2008 Jul 20 10:06 AM

[Jimmy Lathrop:]

What foreclosures? I thought these were all "legacy" loans and we don't have to worry about them any more? I'm confused.

2008 Jul 20 11:24 AM

[Tom Lindmark:]

The real irony is a bailout bill that channells more money into communities to buy and renovate foreclosed homes. Where is the logic in adding more inventory to a problem that is caused by too much inventor. Better to bulldoze them and build parks. At least that way you combat global warming.

2008 Jul 20 02:00 PM

[Kunst:]

The housing problem isn't that prices are going down, it's that they went up ridiculously and sucked in a bunch of buyers who are now underwater. The damage was done on the upside.
When a tsunami hits, the damage isn't caused when it recedes.

The only "solution" would be hyperinflation that essentially wiped out those debts, and the US dollar with it. Otherwise, those who paid too much must either stick it out and pay the full price, or default.

2008 Jul 20 04:48 PM

[secmaven:]

This is an election year. The folks running for reelection cannot return home this fall and tell their constituents that they been able to do nothing about the "mortgage mess." A housing bail out law will be passed. In application it will prove to be a bust. The restrictions on who is eligible will be so tight after the regulations are written that no one will qualify. It is all showmanship.

2008 Jul 20 11:52 PM

[Kunst:]

We're going to give democracy a bad name.

2008 Jul 21 02:07 AM

[tommytwotimes:]

Yeah, while teaching our citizens a lot of bad investment practices. I don't think the gov't should be allowed to do anything with the mortgage industry. If you dig around you'll find the mortgage companies were hiring retired congressmen and senators to lobby for them and not let rules be inducted on mortgage practices and allow prices to be overstated for loans. If your wondering were all that money has gone, it is in the pockets of a bunch of politicians and it looks like their circling the wagons to try and pick up some more.

If they were the ones who got us in this mess, why are we letting them try to get us out? The gov't is notoriously inefficient at managing money. Home prices are falling either way. Why do we need to pay for a bill that will end up with the same result and at the same time let washington get there hands on our money again. And for all those poor people who will loose their home: GO RENT AN APARTMENT AND START SAVING, YOUR BASICALLY RENTING THE HOUSE YOU LIVE IN FOR DOUBLE ANYWAY!

2008 Jul 21 11:27 AM