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Resilience in the Face of Foreclosures How National Actors Shape

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					  Resilience in the Face of Foreclosures:
How National Actors Shape Local Responses



                                Draft
                 Not for Quotation or Attribution




                                   By
                          Todd Swanstrom,
                    University of Missouri, St. Louis



                           Prepared for the
   Brookings-George Washington University-Urban Institute Conference
                Urban and Regional Policy and Its Effects
                           May 20-21, 2010
1


Introduction

        In recent years the United States has witnessed mortgage foreclosure rates not seen

since the Great Depression. According to one estimate, 13 million American homes will be

foreclosed upon by 2014.1 The problem may be getting worse. RealtyTrac reports that

foreclosure filings — default notices, scheduled auctions, and bank repossessions — were

reported on 932,234 properties in the first quarter of 2010, a 7 percent increase from the

previous quarter and a 16 percent increase from the first quarter of 2009.2

        A mortgages foreclosure is basically the failure of a borrower to meet the terms of a

contract with the lender, at which point the property is sold to pay off the loan. If no one bids

high enough to pay off the loan, the lender takes over the property. Although mortgages are

private contracts, their failures have broad public effects. The recent rash of foreclosures has

had a huge impact on the national and even the international economy. Investors in mortgage-

backed securities lost hundreds of billions in equity capital when the mortgages went bad.

These investments were leveraged 10 to 25 times through a variety of complex financial

instruments, such as credit default swaps, which meant that foreclosed mortgages pulled

trillions of dollars of equity capital out of the American economy. As credit froze, the economy

plunged into a deep recession.3

        Besides the macroeconomic effects, foreclosures also have tremendous effects on the

local neighborhoods, cities, and counties in which they foreclosed property is located. Research

has shown that foreclosures decrease the market value of nearby properties, disrupt social

1
  Hatzius and Marschoun (2009); as reported in Standaert and Weed (2010).
2
  RealtyTrac (2010). The Wall Street Journal, however, reported that delinquencies declined in February and
March (Simon, 2010).
3
  Immergluck (2009, p. 159.
2


relations, increase crime, and impose fiscal stress on local governments.4 In this paper I say

little about the impact of foreclosures on the national economy and I only deal with the impact

on individuals and families indirectly. My focus is on the effects of foreclosures on places

(neighborhoods and cities) and the efforts by local actors to minimize damage to places from

the foreclosure crisis.

           I frame my analysis using two broad literatures: regional resilience and federalism. I

both draw on these literatures and critique them using the example of local responses to

foreclosures. The literature on resilience, I argue, provides useful concepts for understanding

why some local actors have been able to respond more effectively to the foreclosure crisis than

others. On the other hand, I argue, the resilience literature tends to treat challenges, such as

foreclosures, as externally driven and intractable, when in fact local actors are often able to

shape the challenge before it hits them. In this case, local actors tried, but largely failed, to

address the root cause of the foreclosure crisis, subprime lending. The federalism literature,

likewise, give us tools for understanding how political actors engage in venue shopping to find

the most advantageous level of decision making and how decisions at different levels of the

American political system impact policy outcomes. I critique, however, the tendency in the

“new federalism” literature to treat central and local actors as locked in a zero-sum

competition. In contrast, I argue, central rules and policies can empower localities to respond

more effectively to the foreclosure crisis.

           The “data” to support my argument comes from the literature on foreclosures and on

case studies of local resilience that I, along with colleagues from around the country,


4
    For a synthesis of the research on the local spillover effects of foreclosures, see Kingsley, Smith & Price (2009).
3


conducted. As part of the Building Resilient Regions project, I conducted a series of interviews

in St. Louis and Cleveland and my co-authors did likewise in Chicago, Atlanta, Riverside-San

Bernadino and the East Bay area.5 I have also been fortunate to be present at two gatherings

organized by the National League of Cities at which local practitioners discussed their responses

to foreclosure. 6 I also draw on the growing literature and websites on local best practices by

such organizations as the National Housing Conference, Brookings, and Living Cities. The

evidence for my argument is mostly qualitative and based on case studies. My focus is on what

local actors have done -- on the policy process more than policy outcomes. I have little hard

evidence on whether these local actions were successful in preventing foreclosures or

minimizing their negative effects. Indeed, as Tom Kingsley has noted, “there is a lack of solid

research literature on such policies and their results.”7 With a few exceptions, we simply do

not know what local actions make a difference.8 Notwithstanding the dearth of hard empirical

evidence, I argue that interventions designed to prevent foreclosures and keep families in their

homes are more cost-effective than programs aimed at minimizing the costs of foreclosure

after they occur. Whether I am correct or not about the need for giving more priority to

prevention, we still need much more research on what kinds of prevention and neighborhood

stabilization work is most effective.

Nature of the Foreclosure Challenge: Subprime Lending and Market Disequilibrium


5
  See Swanstrom, Chapple, and Immergluck (2009).
6
  For the second gathering, in April 2010, I wrote a memo on the St. Louis response to foreclosures and five other
scholars wrote similar memos on their metropolitan areas. I draw freely on these memos. They are available from
the National League of Cities.
7
  Kingsley (n.d.); Kingsley, Smith & Price (2009).
8
  An important exception is the Urban Institute evaluation of the National Foreclosure Mitigation Program (NFMC)
foreclosure counseling program, which it concludes had positive outcomes. Although the program is federally
funded, it is usually implemented by local NeighborWorks organizations. See Mayer et al (2009).
4


        The essence of the foreclosure challenge for places is that it creates an oscillating

imbalance between supply and demand for housing. A period in which demand far outstrips

supply and housing prices soar is followed by a vicious cycle of foreclosures and plummeting

housing prices that leaves a swath of social destruction in its wake. The foreclosure crisis

cannot be understood by linear or one-directional causal analysis. It must be understood in

terms of system dynamics: reinforcing loops of positive feedback that can lock people and

places into cycles of boom and bust that are difficult to control.9

        According to economic theory, the free market is self-correcting ; negative feedback

acts like a thermostat guiding the system toward equilibrium: as demand for housing increases,

the supply of housing responds and satisfies the new demand, thus, moderating price increases

and bringing supply and demand back into balance. What happened in the run up to the

foreclosure crisis is that demand for housing, based on a flood of credit and lax underwriting

standards, soared. The supply of housing, being quite inelastic, failed to keep pace with rapidly

rising demand and housing prices began climbing rapidly in most areas. House prices increased

far beyond the pace of economic essentials; for example, monthly housing costs grew as a

proportion of income – a trend which in the long run was unsustainable.10 Normally, if

households take out loans that are unsustainable, they will default and quickly go into

foreclosure.11 In this case, housing price appreciation covered over the unsustainability of the



9
  For an introduction to system dynamics thinking, see Richardson (1999).
10
   U.S. Department of HUD (2010, p. 38).
11
   Of course, another market mechanism that should have prevented the crisis was that risky mortgages destined
to fail should have been unable to be sold on the secondary market, thus choking off mortgage credit and
moderating demand. Federal Reserve Board Chairman Alan Greenspan clearly believed, at the time, that market
mechanisms would correct any imbalances and “the benefits of broadened homeownership are worth the risk [of
foreclosures].” (Greenspan, . He now has admitted he was wrong. The reason why is a long story involving the
5


loans: if borrowers were unable to meet monthly payments, they could simply refinance or sell

the home to pay off the loan. A self-reinforcing cycle of easy credit, rising demand, and soaring

prices was set in motion.

        The rash of foreclosures that began in 2006-2007 set in motion a vicious cycle in the

opposite direction: foreclosures suddenly flooded the market with a supply of homes driving

down prices, which left more people vulnerable to foreclosure, further driving down prices

(Figure 1). In addition, burned by foreclosures, lenders tightened their underwriting standards,

further depressing effective demand for homes, reinforcing the cycle of rising foreclosures and

falling prices. And as home prices plummeted, consumer spending fell, increasing

unemployment and tipping more households into foreclosure.

        There has been a great deal of debate in the literature on the underlying cause of the

foreclosure crisis. Some argue that it is a classical housing bubble that, when it burst, left

borrowers underwater and, then, according to option-based theory, borrowers ceded their

property to the lender in a so-called “ruthless” default.12 Others point to rising unemployment

and other triggering events as the primary causes of foreclosures. And still others assert that

the Community Reinvestment Act (CRA) pushed lenders into to make loans to borrowers who

lacked the economic resources to sustain homeownership.

         A HUD “Report to Congress on the Root Causes of the Foreclosure Crisis” debunks all

three of these explanations.13 Although declining prices are strongly correlated with

foreclosures, they are not the root cause of the foreclosure crisis. Falling home prices simply


securitization of mortgages, the invention of complex new ways of insuring pooled mortgages, corrupt ratings
agencies, and other factors. See Immergluck (2009).
12
   U.S. Department of HUD (2010).
13
   U.S. Department of HUD (2010, p. 1).
6


took away one way for people who had unsustainable loans to avoid foreclosure (refinancing or

selling their home to pay off the loan). Past foreclosure waves were often caused by economic

weakness but the recent wave of foreclosures, the HUD report observes, occurred before

unemployment began to rise (p. 21). In fact, it is more correct to say that foreclosures caused

economic weakness, not that economic weakness caused foreclosures. (Now, of course, we

are facing a second wave of foreclosures, often of prime loans, driven by rising unemployment

and underemployment.14) And government regulations, like CRA, were not a significant cause

of the foreclosure crisis, the HUD report concludes, because the vast majority of loans that

went into foreclosure were originated by lenders who were not regulated by the federal

government.


                   Lenders take losses       Fewer Loans         Fewer
                                                                 Homebuyers

Subprime
                 Foreclosures            More houses            Declining Home
 loans
                                         for sale               Values



                                     Higher                        Less Consumer
                                     unemployment                  Spending



                                   Figure 1.
                         Vicious Cycle of Foreclosures




           Rejecting the bursting housing bubble, the faltering economy, and misguided federal

regulations as primary causes, the HUD Report to Congress concludes that “highly risky loans …

were the root cause of the current crisis.” In short, the recent foreclosure crisis was driven by a

14
     Edmiston (2009).
7


huge increase in risky loans that were doomed to fail. The market share of risky loans

(subprime, Alt-A, and home equity loans) increased from 16 percent in 2003 to 48 percent in

2006.15 Collapsing housing prices suddenly left people vulnerable to foreclosure, but the

collapse of housing prices was not the driver of the crisis. In fact, the authors of the HUD report

stress, rising prices were themselves significantly caused by the flood of easy credit and loose

underwriting standards. When enough borrowers defaulted on their loans and went into

foreclosure, the whole house of cards collapsed into a vicious cycle in which supply exceeded

demand and plummeting house prices and rising unemployment exposed more people to

foreclosure (Figure 1). In short, the rapid rise of risky subprime loans was the driver of the

foreclosure crisis.

The Spatial Dimension of the Foreclosure Challenge

           Local actors have a great deal of responsibility for dealing with the costs of foreclosure

but relatively little power over foreclosures. The positive feedback loops discussed above that

have driven foreclosures can also take root in neighborhoods where the foreclosures first

appear, setting in motion processes of disinvestment and decay. Although local actors bear

many of the spillover costs of foreclosure, subprime lending was permitted and encouraged by

state and federal governments, which created what Ed Gramlich called “a gigantic hole in the

supervisory safety net”.16 Subprime lending was further enabled by Wall Street investors who

bought up subprime loans without properly evaluating the risks. Local governments and actors

had responsibility for cleaning up the mess from the spillovers of foreclosures, but they had

little power to prevent subprime lending.

15
     U.S. Department of HUD (2010, p. 25).
16
     Gramlich (2007, p. 21).
8


                  The literature on the local spillover effects of foreclosures is not huge but it is

enough to identify the major negative externalities of foreclosures with confidence.

Foreclosure spillovers fall into three categories: 1) declining property values; 2) crime and

social disorder; 3) Local government fiscal stress and deteriorating services.17 This is not the

place to discuss the full range of local spillovers, but a quick survey will demonstrate that the

local effects are significant indeed.

         Declining Property Values

         The impacts of foreclosures can be Scholarly research has consistently found a negative

impact on the market value of homes located within approximately 1/8 of mile (660 feet) of a

foreclosure. The Center for Responsible Lending estimates that by 2012 ninety-two million

households will suffer declines in property values totaling $1.2 trillion.18 One of the most

broadly based studies covering 628,000 repeat sales transactions in 13 states found a negative

impact of 1.3 percent on properties located within a 300 foot radius of a foreclosure and a drop

of 0.6 percent within the 660 foot radius.19 A study of St. Louis County foreclosures between

1998 and 2007 found a drop of about 1.0 percent in the sales prices of properties located

within 1/8th of a mile of a foreclosure.20 In a study of Chicago, Immergluck and Smith (2006)

found a drop in market value within the 1/8 of a mile radius that varied from 0.9 percent to 1.8

percent. Using the conservative Immergluck and Smith estimate (0.9 percent), the Center for




17
   This categorization is taken from Kingsley, Smith, and Price (2009), a valuable synthesis of the research on the
local spillover effects of foreclosures.
18
   Standaert and Weed (2009, p. 72).
19
   Harding, Rosenblatt & Yao (2008).
20
   Rogers and Winter (2009).
9


Responsible Lending (CRL) calculated that on average homeowners located near a foreclosure

will lose about $5,000 in value. 21

        Social Disorder and Crime

        By creating involuntary moves, foreclosures disrupt the community fabric and deplete

social capital. Children are in many ways the most disturbing innocent victims of foreclosure.

When they are pulled out of one school and put in another their learning is disrupted.

According to one estimate, 1.952 million children were impacted by foreclosures as a result of

subprime loans made in 2005-2006.22 This imposes huge costs on families, communities, and

schools. Frequent residential moves can increase violent behavior in high school by 20 percent

and reduce the chance of graduating from high school by more than 50 percent.23 Foreclosures

can also damage the health of children, negatively affecting diet and healthy body weight. In

addition, foreclosures put stress on families, leading to higher rates of divorce, child abuse, and

addictive behaviors.

        Foreclosures are also associated with crime. According to “broken windows” theory,

signs of disorder in a neighborhood, as small as a broken window that is not fixed, encourage

crime.24 Foreclosures, especially when the home lies vacant and not properly maintained (such

as tall grass or trash out front), can create a sense of disorder in a neighborhood and encourage

crime. Research has confirmed this connection. A study of Chicago found that for each 1

percentage point increase in the foreclosure rate, the number of violent crimes in a census tract




21
   Immergluck and Smith (2006A); Center for Responsible Lending (2008).
22
   Lovell & Isaacs (2008).
23
   Rumberger (2003).
24
   Kelling & Coles (1996).
10


will increase by 2.33 percent.25 A study by the Charlotte-Mecklenburg Police Department found

that both violent and property crime rates were higher in the high-foreclosures neighborhoods

compared to neighborhoods that had not yet experienced high rates of foreclosure.26

        Local Government Fiscal Stress and Deteriorating Services

        The impact of foreclosures on local governments is double-edged—both on the revenue

and expenditure side. On the revenue side, most analysts agree that foreclosures will decrease

revenues. The impact of foreclosures on tax revenues, especially property taxes, is significant.

Once assessments catch up with declining property values, governments will be forced to

increase local tax rates to maintain property tax revenue. Additionally, local governments will

have to deal with increased tax delinquencies and failure to pay utilities.

        At the same time that revenues are declining, local governments are bound to face

increased costs as employees miss work, productivity declines, and families seek additional

social services. These indirect costs are difficult to estimate but researchers have measured the

direct costs of foreclosures on local governments. The best scholarly study on the cost of

foreclosures to municipalities examined Chicago, quantifying costs of foreclosure based on five

scenarios.27 If a property goes into foreclosure and is quickly put back on the market, the

researchers estimate it will cost the local municipality only $430. At the other end, if the

foreclosure leads to vacancy, abandonment, and fire, ultimately requiring demolition, the cost

to the local municipality soars to $34,199. Based on the Apgar and Duda study, the Joint

Economic Committee of the U.S. Congress estimated average costs at $19,227.


25
   Immergluck & Smith, 2006B.
26
   Bess (2008).
27
   Apgar & Duda (2005).
11




         Subprime
                         Foreclosures                 Glut of                           Declining Home
          loans
                                                      houses on                         Values
                                                      market


                                                                                            Vacancy &
                                                              Rising Crime                  abandonment

                                                                           Government Fiscal Stress:
                                                                           Rising Taxes & Declining Services


                                     Figure 2.
                     Foreclosures and Reinforcing Processes of
                              Neighborhood Decline



         As the Apgar and Duda study suggests, the costs of foreclosure vary significantly from

place to place. The negative impact of foreclosures on places depends on foreclosure density

and the strength of the local housing market. Dispersed foreclosures in strong housing markets

have minimal effects. Concentrated foreclosures in weak housing markets can have massive

effects. In strong markets, the housing market will soak up the relatively small number of

foreclosed properties and quickly put them back on the market. Other than an unusually large

number of “For Sale” signs, a casual observer driving through the neighborhood would see little

change.28 On the other hand, concentrated foreclosures in weak markets can create positive

feedback loops that reinforce neighborhood decline (Figure 2).




28
  But the costs to individuals and families can still be considerable. Indeed, in strong market metropolitan areas
foreclosures may be harder on families because affordable replacement housing is more difficult to obtain than in
a weak market. For a review of the relatively thin scientific research on the effects of foreclosures on families and
individuals, see Kingsley, Smith & Price (2009).
12


        Reinforcing processes of neighborhood decline are rooted in the fact that real estate

markets are highly social or interactive. The self-correcting equilibrium of market economics is

based on rational actors making independent decisions. If the housing prices fall below the

inherent characteristics of the neighborhood (condition of stock, amenities, location relative to

jobs, etc.), then presumably buyers, seeing an opportunity, will jump in and bring prices back up

to equilibrium. But as the growing literature on behavioral economics has taught us, market

actors do not always act rationally or independently.29 Economic decision makers are prone to

social contagion in which they follow the herd rather than make cold-hearted rational decisions

based on the merits of each case. This is especially true in the case of real estate markets.

Admittedly, market fundamentals cannot be ignored indefinitely. Market fundamentals always

reassert themselves in the long run. But as Keynes once remarked: “In the long run we’re all

dead.” It is like having a thermostat that brings your home back to 70 degrees, but only after

forcing you to swelter in 90 degree heat for days.

        This herd-like destabilizing behavior was clearly evident in both the inflating of the

housing bubble and its subsequent collapse. Real estate markets are especially prone to social

contagion because the value of property depends so much on what happens to the parcels

surrounding it. The guiding principle of real estate is “location, location, location.” When

foreclosures occur in sufficient numbers in a neighborhood with weak market demand, they

can tip the neighborhood into a reinforcing cycle of disinvestment. Just as housing prices

climbed beyond economic fundamentals during the period of loose credit, housing prices can



29
  For an insightful application of behavioral economics to the foreclosure issue, see Barr, Mullainathan and Shafir
(2008).
13


also fall further after foreclosures than would be expected given the economic fundamentals of

the area.

        The recent wave of foreclosures flooded across a metropolitan landscape that varied

tremendously in market strength. Some metropolitan areas, driven by robust job growth and

high levels of immigration, have a perpetual shortage of housing relative to demand. As a

result, the so-called sand states experienced huge run ups of housing prices in the boom

followed by precipitous price declines. Because of the underlying strong market, however,

metropolitan areas in Florida, Arizona, and California have experienced relatively low levels of

vacancy and abandonment due to foreclosures. Even in the strongest regional housing

markets, however, there are pockets of market weakness. Exurban areas with so-called “drive

‘til you qualify” mortgages did suffer from a build-up of REOs.30

        Weak market metros are more vulnerable to foreclosures. When combined with

imbalances between supply and demand within regions, the spillover effects of foreclosures

can be severe. Many central cities in the Rustbelt have suffered from an imbalance of supply

and demand for decades resulting in vacancy and abandonment at the end of the filtering

chain. In many metropolitan areas, more houses are built on the suburban fringe than there

are new households in the region. In the 1990s, for example, the City of Buffalo produced 3.89

more units of housing than there were new households formed in the region.31 The inevitable

result was vacant and abandoned housing. Concentrated foreclosures can tip transitional

neighborhoods over into a cycle of disinvestment, vacancy, and abandonment.32


30
   Immergluck (2009).
31
   Bier & Post (2006).
32
   Goldstein (2008); Mallach (2008).
  14


                Foreclosures are not randomly distributed across metropolitan areas. Subprime

  lending, which is highly correlated with foreclosures, was highly concentrated. Foreclosures are

  correlated with each other in space. Subprime loans, the root cause of the crisis, were not sold

  they were aggressively marketed – especially in minority neighborhoods. They were not

  marketed to the poorest areas but to moderate and middle-income minority neighborhoods.

  Many of these neighborhoods had experienced revitalization, often due to the hard work of

  community development corporations. Ironically, this hard work in pushing up market values

  may have attracted subprime lenders.33 Concentrated foreclosures can set in motion a cycle of

  decline that can wipe out decades of community development that built up assets: physical

  capital, social capital, and financial capital.34




                                                                                                 Abandonment
                                                                               Vacancy
                                                            Sheriff’s
                                                              Sale
                                        Foreclosure
                                          Notice
Risky lending         Delinquency




  33
     For example, Slavic Village, the epicenter of the foreclosure crisis in Cleveland, had one of the most active and
  successful CDCs in the area.
  34
     Homes equity represents 60 percent of the total wealth of middle class households. Before the recent wave of
  foreclosures, African American household wealth was less than one-tenth of white households (Shapiro 2004, p. 47
  and 107). There is every reason to believe that the wave of foreclosures wiped out proportionally more home
  equity among African American households than among whites. (See Kochar and Gonzalez-Barrera (2009).)
15




                                                                                                     Magnitude of
                                                                                                     Spillovers


       Stronger Housing Market                                       Weaker Housing Market




                        Figure 3. Rising Spillovers in Weak Market Areas



       In conclusion, the fundamental challenge of foreclosures for places is that they can

cause severe imbalances of supply and demand for housing. Foreclosures have substantial local

spillover effects and when they are concentrated in weak market areas, they can set in motion

destructive cycles of decline. As Figure3 depicts, the weaker the housing market the greater

the likelihood that foreclosures will result in vacancy and abandonment and the greater the

magnitude of the spillover effects. Weak market areas are especially vulnerable to social

contagion from foreclosures. In such areas, minimizing the spillover effects after foreclosures

have occurred is difficult. Local actors may be forced to let the “disease” run its course but in

the process much of the physical, social, and household assets accumulated in that place will be

destroyed. Inoculating places against the contagion would make more sense. But as we will

demonstrate in the following section, local actors, who are responsible for dealing with the

spillover effects of foreclosures, had little power to control risky lending, the primary cause of

the recent wave of foreclosures.

Foreclosure Prevention: Controlling Subprime Lending
16


        The most effective way local actors could have responded to the foreclosure crisis

would have been to limit subprime lending within their borders. When cities acted to regulate

subprime lending, however, courts ruled that they lacked home rule powers for that purpose or

that state laws preempted local laws.35 Similarly, when states stepped in regulate subprime

lending, they were preempted by federal laws. Finally, competing federal regulators engaged in

a “race to the bottom” that gutted regulation of subprime lending. Successful venue shopping

by the mortgage lending industry within the federal government and across federal, state, and

local governments undercut efforts to regulate subprime lending.36

        The origins of subprime lending go back to a 1980 federal law which phased in the

abolition of state usury limits on first mortgages by depository institutions.37 Part of the

rationale was that allowing higher interest rates would increase access to credit by higher risk

households and give them a chance to become homeowners. In 1982 another federal law

allowed mortgage companies, that originate loans and sell them to investors, to opt for federal

regulations rather than the regulations of the state in which they were located.38 The vast

majority of subprime loans were originated by mortgage companies. In 1994 the federal

government did enact the Home Ownership and Equity Protection Act (HOEPA) which

prohibited certain loan terms and practices on high-cost loans. The definition of “high cost”,

however, was so high (generally, 8 percent above the rate on comparable Treasury securities)




35
   Frug and Barron (2008, p. 196).
36
   The story of the failed efforts of local, state and federal regulators to limit subprime lending is told in U.S.
Department of HUD (2010) and more completely in Immergluck (2009). I draw freely from these accounts. For the
concept of “venue shopping” see Baumgartner and Jones (1993).
37
   Depository Institutions Deregulation and Monetary Control Act (DIDMCA).
38
   Alternative Mortgage Transaction Parity Act (1982)
17


that it applied to very few loans. In 2006, for example, less than 0.1 percent of refinancing and

home improvement loans fell under the law.39

        Subprime lending, greenling as opposed to redlining, began to emerge as a problem in

the 1990s and in 1999 North Carolina became the first state to enact comprehensive anti-

predatory lending legislation. The law was modeled on HOEPA but set the threshold much

lower so that it applied to large segment of subprime loans. Other states followed suit so that

by 2007 only seven states had no mini-HOEPA statutes on the books to regulate subprime

lending. 40 These laws were generally ineffective, however.41 Many state anti-predatory

lending laws were weak but another reason why they were ineffective is that they were

preempted by federal regulators. Federal regulators receive part of their funding from fees

paid by the institutions they regulate. Financial institutions have some freedom to choose

which regulator they will fall under and they shop for the best deal. Federal regulators

competed to see who could offer the most preemption of state mortgage regulations – and

therefore attract the greatest number of members and highest fees. In 1996, the Office of

Thrift Supervision (OTS) issued a sweeping regulation preempting all state laws regulating

mortgage lending for federal savings institutions. Under pressure from its members, in 2004

the Office of the Comptroller of the Currency (OCC) issued a similarly sweeping preemption

regulation for all national banks. Both agencies exempted mortgage banking operating




39
   Avery, Brevoort & Canner (2007) as reported in U. S. Department of HUD (2010, p. 34).
40
   Bostic, et al (2007) as reported in U. S. Department of HUD (2010)).
41
   According to one study passage of these laws was actually associated with an increase in subprime lending
(Bostic, et al, 2007).
18


subsidiaries, which were more involved in subprime lending, from state regulation as well. In

2007, the U.S. Supreme Court upheld this extension of preemption powers. 42

        As is often the case in our federal system, when the federal and state governments

withdrew from effective regulation of subprime lending, local governments moved in to fill the

gap. A 2005 study identified eighteen local anti-predatory lending laws.43 For example, Chicago

and Cook County enacted anti-predatory lending laws in 2000 and 2001, respectively, which

sought to withdraw municipal business and deposits from firms that engaged in predatory

lending. However, most local laws were preempted by state legislation or state court ruled that

they lacked authority to regulate financial institutions. An excerpt from a dissenting opinion in

a California Supreme

Court case that invalidated Oakland’s pioneering predatory lending legislation clearly expresses

why local governments should have authority in this sphere:

        Oakland’s particular interest in regulating subprime loans goes beyond merely

        protecting its particularly vulnerable citizens …. Predatory home mortgage lending has

        enormous impacts on targeted neighborhoods. … “Foreclosures, especially in low- and

        moderate-income neighborhoods turn what might be typically viewed as a consumer

protection       problem … into a community development problem, in which increased

foreclosures lead to property abandonment and blight.”44




42
   Immergluck (2009, p. 179). Besides refusing to regulate the origination of subprime loans, the federal
government also promoted the securitization of subprime loans which provided massive new capital streams for
subprime lenders and also made it more difficult for subprime loans to be modified, as I discuss later. Immergluck
(2009) tells this story in some detail.
43
   Pennington-Cross and Ho (2005).
44
   Quoted in Frug and Barron (2009, p. 197).
19


       In short, government efforts to regulate subprime lending, the root cause of the

foreclosure crisis, were gutted by state preemption of local laws, federal preemption of state

laws, and a race to the bottom by federal regulators. Most subprime loans were originated by

mortgage brokers who were lightly regulated by the states and federal government. After

foreclosures led to huge losses by investors in pools of mortgages containing subprime loans,

subprime lending largely came to a halt, because investors refused to buy them any longer. By

that time, however, subprime loans were going into default all over the nation. Preventing

foreclosures and their massive spillovers on local communities is much more difficult after

subprime loans have been originated than before. In any case, that is the situation local

authorities found themselves in.

Foreclosure Prevention in the Wake of Subprime Lending: Loan Modifications

       Strong arguments can be made for limiting foreclosures both from the viewpoint of

private investors and the public. Given the transaction costs and loss in home value following a

foreclosure, the investors holding mortgage-backed securities would often be better off if the

loan were modified to enable the borrower to stay in the home making lower monthly

payments. Many loan modifications are win-win for the lender and the borrower. The public

has an additional interest in preventing foreclosures, given their large spillover effects,

especially for weak market areas with concentrated foreclosures. Despite the powerful private

and public motives for limiting foreclosures, the rate of loan modifications has been

disappointingly low. Local actors, particularly housing nonprofits, aided by federal grants, have

been resilient in responding to the need for foreclosure prevention by creating housing

counseling networks with broad public outreach. However, vertical disintegration of the
20


mortgage market has pulled key decisions about loan modifications into the hands of remote

servicers constrained by hyperrigid mortgage pools.45

         Investors in mortgages lose a great deal when the mortgage goes through foreclosure.

Estimating these losses is difficult because they can vary so much in different parts of the

country and under different scenarios. Clearly, however, the losses are high. Loss severities

have been estimated at about 50 percent for prime mortgages and 70 percent for subprime

mortgages.46 According to one study of subprime loans going through foreclosure, about 42

percent of the loss was due to legal fees, sales commissions, maintenance expenses, and

missed mortgage payments. About 44 percent of the loss was a deadweight loss – a decline in

the value of the home for which there is no compensating gain by anyone else.47 Part of the

loss is due to the general decline in prices. Part is due to vandalism and stripping. And a

significant part is due to the stigma that a foreclosure sale puts on a property – which is

estimated at about 28 percent below equivalent standard sales.48 A study of 900 subprime

loans estimated the cost to investors of foreclosure at over 50 percent. With an average

principal balance of $190,000 that means a loss of about $95,000 on each foreclosure. That

leaves a lot of room to work out a win-win loan modification with the borrower.

         The deadweight loss to private investors is much more severe in weak market

metropolitan areas. In the City of Cleveland, for example, most properties that go through

foreclosure are taken over by the bank, so-called real-estate owned properties (REOs). In 2007

properties sold by banks in Cleveland fetched only 13 percent of their estimated market value

45
   Hyperrigid is not my term but is take from Gelpern & Levitin (2009).
46
   Cordell, et al (2009, p. 7).
47
   Cordell et al (2008, p. 12)
48
   Cordell et al (2009, p. 8).
21


before foreclosure filing. In 2008, 80 percent of properties sold out of REO in Cleveland’s East

Side sold at extremely distressed prices of less than $10,000.49 In the Cleveland area property

losses by foreclosed properties now exceed a billion dollars. Investors should be highly

motivated to prevent foreclosures and cut their losses.

        The public sector has an additional motive to prevent foreclosures because of the

massive negative spillovers discussed earlier. It would especially make public policy sense to

prevent foreclosures in transitional areas where risky loans are concentrated and their

foreclosure could set in motion reinforcing cycles of decay. Some of these external costs are

quantifiable, such as loss by nearby homeowners, but many of these costs are difficult to

quantify. The existence of nonmonetary benefits of stable homeownership, however, is

indicated by the fact that homeowners put a value on staying in their homes even when it does

not make economic sense. Studies have shown that only a small minority of homeowners who

are underwater, owing more on their homes than they are worth, default and go into

foreclosure. A study of all homeowners in Massachusetts, for example, found that in the early

1990s only 6.4 percent who were underwater ended up in foreclosure.50 This suggests that

homes are not just a financial investment but have substantial “use values” that are

nonfungible and nonportable, such as belonging to a community, accumulated social capital,

and a satisfying daily round.51 Parents, with good reason, are reluctant to pull their children

out of local schools in order to achieve a financial benefit. In short, the economic and




49
   Coulton, Schramm & Hirsch (2010).
50
   Cited in U.S. Department of HUD (2010, pp. 15-16). The HUD report cites a number of other studies to support
this finding.
51
   For an explication of the concept of use values, see Logan and Molotch (1987).
22


noneconomic spillovers of foreclosure make a powerful argument for public interventions to

prevent foreclosures.

        The main argument against public intervention to prevent foreclosures is the risk of

creating a moral hazard: helping homeowners who took on risky debt could encourage more

risky behavior in the future. This is a valid concern. It is very difficult to estimate the effect of

loan modifications on future household behavior but the substantial benefits of loan

modifications seem to outweigh concerns about moral hazards. First, the explosion of risky

mortgages appears to be less related to risky consumer behavior and more connected to

deceptive lending practices by mortgage brokers. Sudden risky behavior by borrowers does

not explain the timing of the crisis; the emergence of risky and exotic mortgage products does.

Many borrowers did not know what they were agreeing to when they signed a mortgage.

Education of borrowers about the risks subprime lending is helpful but given the complexity of

mortgage instruments, the best way to limit future risky lending is to regulate risky and

unsustainable lending practices, such as negative amortization, yield-spread premiums, no-doc

loans, prepayment penalties, and exploding ARMs. Given the seriousness of the consequences

of concentrated foreclosures it makes sense to act quickly to minimize the damage. A

firefighter does not first ask whether the homeowner was smoking in bed before putting out

the fire.

        In fact, local actors have been highly resilient in responding to the challenge to keep

people in their homes. Resilience can be defined as the ability to respond to a challenge by 1)

redeploying assets or expanding organizational repertoires; 2) collaborating within and across

public, private, and nonprofit sectors; 3) mobilizing or capturing resources from external
23


sources.52 Using this definition local housing nonprofits have been quite resilient. They shifted

employees from housing rehabilitation and other activities to foreclosure counseling. This

effort was greatly aided by the National Foreclosure Mitigation Counseling (NFMC) program

funded by the federal government and administered through NeighborWorks America. NFMC

counseling agencies provide free counseling to homeowners who are in trouble, not only

helping them to avoid foreclosure but also advising them in the event of a foreclosure on how

to find replacement housing and access social services. Since 2007 approximately $410 million

has been invested in this program mostly for grants to local counseling agencies that receive

between $150 and $350 per client depending on the extent of the counseling.53 As of

November 2009 762,284 clients had been served.54 Standards have been established to insure

quality. Counselors become HUD-certified by receiving training in the intricacies of the home

financing, usually funded by scholarships.

        A good example of resilient local efforts to prevent foreclosures is the Homeownership

Preservation Initiative (HOPI) in Chicago. Begun in 2003, HOPI included Neighborhood Housing

Services of Chicago, many local CDCs, nonprofit counseling organizations, legal services

providers, the City of Chicago, and local foundations. HOPI used the City of Chicago’s 311

nonemergency hotline to link homeowners to counselors. By May 2008 HOPI reported it had

prevented 1,700 foreclosures. Foreclosure prevention has been vigorous in other metropolitan

areas, as well. In 2005 Cuyahoga County launched a foreclosure initiative that included nine

housing nonprofits, numerous municipalities and a number of lenders. Funds from Temporary
52
   Swanstrom, Chapple and Immergluck (2009, p. 4).
53
   For helping with HAMP applications, counseling agencies can now receive up to a maximum of about $500, it is
my understanding.
54
   As reported in the Fourth Congressional Report accessed at:
http://www.nw.org/network/nfmcp/congressional_reports.asp.
24


Assistance to Needy Families (TANF)and fees from tax delinquent properties were shifted to

foreclosure counseling. The County invested almost $2.5 million in the program up to 2008 and

raised about a half a million dollars from local foundations and banks. Between March 2006

and February 2007 the program reported preventing 1,497 foreclosures. 55 The City of St.

Louis has now invested more than $1 million in foreclosure prevention, including the creation

of a foreclosure rescue fund that can make small payments to help homeowners secure a loan

modification. Foreclosure counseling agencies in St. Louis partnered with the local public

television station (KETC) to create programs and a local website to encourage people to seek

help. The KETC initiative was later duplicated in twenty-five cities around the country with the

help of grants from the Corporation for Public Broadcasting.56

        The capacity of local actors to engage in foreclosure prevention varies significantly.

CDCs have been “first responders” in the wake of the foreclosure epidemic. Unfortunately,

many suburban areas hard-hit by foreclosures lack robust networks of CDCs.57 Chicago

responded to this gap by creating a regional HOPI, RHOPI, which was led by NHS, Chicago

Community Trust, and the Federal Reserve Bank of Chicago. The RHOPI foreclosure counseling

task force developed a report mapping gaps in access to housing counseling agencies, which

was used to better target counseling resources. Significant foundation and government

funding for counseling in the Chicago area has filled many gaps. But this is not true in other

metropolitan areas.58



55
   Swanstrom, Chapple & Immergluck (2009).
56
   Swanstrom (2010).
57
   Swanstrom, Chapple & Immergluck (2009) provides GIS maps of the location of housing nonprofits in
metropolitan areas, showing their central city concentration.
58
   Swanstrom, Chapple & Immergluck (2009).
25


        In 2009, the Urban Institute (UI) published preliminary findings of its evaluation of the

NFMC counseling program.59 While not meeting the gold standard of double-blind

experimental research, the study uses rigorous methods to isolate the effects of counseling. UI

examined approximately 61,000 households that received foreclosure counseling and

compared them to a control group of 61,000 similar households that did not receive foreclosure

counseling. The researchers found that the program had modest effects on homeowners who

were two to three months delinquent on their loans when they started counseling, but more

dramatic effects helping homeowners “cure” an existing default. Counseled homeowners were

60 percent more likely to “cure” a foreclosure than those who had not received counseling.

Additionally, the Urban Institute study concluded that loan modifications received by

homeowners through the NFMC program resulted in significantly reduced monthly mortgage

payments after a loan modification (-$454), thereby further decreasing the likelihood of future

defaults and foreclosures.

        Research suggests that foreclosure counseling can improve outcomes and help keep

families in their homes. However, the success of foreclosure counseling at best only chips away

at the margins of the problem. The Urban Institute study applied its estimates to the

approximately 260,000 clients who received counseling in calendar year 2008. They calculate

that 880 additional loans would have gone into foreclosure in the absence of counseling and

2,195 households that were in foreclosure at the time they entered counseling were able to

“cure” the foreclosure as a result of the counseling. They use the estimate of a HUD report that

59
   Mayer, et al (2009). Collins, et al (2009) conclude that when offered in conjunction with state
foreclosure prevention policies or programs counseling reduces delinquency rates and foreclosure
filings. They also report on one other study that found a positive association between counseling and
foreclosure cure rates.
26


each foreclosure creates costs of about $37,000. Assuming that each homeowner prevented

from going into foreclosure and each homeowner in foreclosure cured is a foreclosure avoided,

then NFMC counseling had benefits of $113,810,000. As I discuss above, the benefits of

foreclosure prevention are considerably higher than this if you count the nonmonetary costs to

households and places. In any case, even at the maximum cost per client served of $350, NFMC

counseling cost only $91 million – leaving a positive benefit-cost ratio. The benefits of

taxpayer-funded counseling are significant. One study found that about half of households that

went through foreclosure never even communicated with their servicer.60 Early

communication increases the likelihood of staying in your home and foreclosure counseling

increases this. The authors conclude that “the availability of the service [foreclosure

counseling] is low relative to the need.”61 Clearly, we should invest more in foreclosure

counseling. Metropolitan areas that have invested in foreclosure counseling have probably

reaped social benefits far beyond the costs.

            The problem with foreclosure counseling is that it does not get close to addressing the

magnitude of the problem. The Urban Institute estimates that 3,095 foreclosures were

prevented through foreclosure counseling. In a year when about 2 million households went

through foreclosure, that is clearly not enough. The main reason for the low rate of foreclosure

prevention is that lenders are reluctant to modify many loans.

            In order to address the problem, the Obama Administration launched the Making Home

Affordable (MHA) Program in March 2009 which was designed to help 7-9 million households.



60
     Cutts & Merrill (2008, p. 211).
61
     Cutts & Merrill (2008., p. 252).
27


Over 85 percent of all mortgages are now covered by the program.62 Intended to strengthen

the ability of homeowners and local counselors to negotiate sustainable mortgage

modifications, the program has two main components—a Home Affordable Refinance Program

(HARP) for homeowners whose loans are held by the government-sponsored entities, and a

Home Affordable Modification Program (HAMP) for modifying loans held by conventional

lenders. Of the two, HAMP has become the more important program for most local

homeowners, and it has also been the more complex and controversial program for the federal

government to implement. The main components of the program are incentives to servicers to

modify loans and requirements to bring monthly payments down to 31 percent of household

income. The bar graphs below show that although over 1.1 million trial modifications had been

initiated by March 31st, but only 230,801 permanent modifications had been completed. The

rate of loan modifications is growing but at this rate it will never come close to meeting initial

expectations.




62
     Cordell, et al (2009).
28




       Source: Making Home Affordable (2009)



       The main reason for the slow pace of loan modifications and foreclosure prevention lies

with the servicers and the nature of mortgage securitization. The resilience literature teaches

that specialization and scale can increase efficiency at the same time that they reduce

resiliency. For example, companies with diverse and redundant supply chains will be less
29


vulnerable to an interruption in the supply chain.63 Local housing nonprofits were small and did

not have a highly developed internal division of labor and therefore they were able to shift

organizational routines and employees to address the foreclosure challenge. Servicers were

just the opposite. Over time, the servicers had become large, specialized organizations highly

efficient at collecting and distributing mortgage payments. “As a result of the consolidation in

the industry, servicers have realized large economies of scale in payment processing and

collections, so that the costs of servicing have trended down over time.”64 Loss mitigation is

not subject to economies of scale and therefore did not fit the business model of servicers.

Servicers were not prepared to take on the task of loss mitigation and loan modifications. They

lacked qualified staff who understood loan underwriting. Moreover, they were distant from

local real estate markets and therefore not in a good position to understand how much

properties were really worth.

         The whole process of securitization of mortgages and the pooling and servicing

agreements (PSAs) that govern them make loss mitigation extremely difficult. Over 90 percent

of mortgages initiated in recent years have been securitized.65 Gelpern and Levitin call the PSAs

“Frankenstein contracts” – brilliant human creations that come back to haunt us because we

have no way of stopping the destruction they wreak. “The continuing foreclosure epidemic

holds an important lesson for the future: even where rigidity makes perfect sense for the

contracting parties, widespread barriers to modification can unleash catastrophic social




63
   Sheffi (2007).
64
   Cordell, et al (2008, p. 15).
65
   Gelpern & Levitin (2009, p. 1081).
30


consequences.”66 We want contracts to be difficult to break, the authors stress, however,

“private contracts must not be read to interfere with legitimate public policymaking.”67 They

cite numerous instances, including corporate bonds and policies initiated in response to the

foreclosure crisis of the Great Depression, where contracts were renegotiated in order to

protect the parties involved and the broader society.

        The rigidities of PSAs come in many different forms. PSAs sometimes simply limit the

number of mortgages that can be modified. Another problem is that the mortgage pools are

owned by thousands of investors from all over the world and in many cases modifying loans

requires the consent of each investor to modify its right to receive principal and interest

payments. Modifying a particular loan can affect different investors different because they

invest in different “tranches” or slices of the overall pool. The result can be so-called “tranche

warfare.”

        Servicers also have more incentives to proceed to foreclosure or stretch out the process

than they do to modify a loan.68 Servicers are paid a servicing fee which is based on the unpaid

principal balance of the loans in the pool and therefore, other things being equal, they do not

want to refinance loans or reduce the principal owed. Services make money on loans in

default, through late fees and “process management fees.” If a loan goes through foreclosure,

servicers recover all their expenses before any of the investors get paid. Servicers get paid

nothing for the loss mitigation work that they perform. As the HUD report to Congress

concluded: “[T]here is growing consensus that the rules governing securitization can and do


66
   Gelpern & Levitin (2009, p. 1080).
67
   Gelpern & Levitin (2009, p. 1134).
68
   My discussion of servicer incentives relies on Thompson (2009).
31


limit the flexibility of servicers to pursue modifications, even in situations where an aggressive

modification would benefit both the borrowers and the investors.”

       In sum, local actors have often been resilient in pursuing foreclosure prevention by

establishing foreclosure counseling networks and engaging in broad collaborations to reach out

to distressed homeowners. Part of the work of foreclosure prevention must be local. Loan

modifications need to be tailored to the individual. Face-to-face counseling is more effective at

generating the trust and exchange of information necessary for a successful modification. The

willingness of a lender to modify a loan will be based partly on the value of the home in a

foreclosure sale and this will require knowledge of local real estate markets. In addition,

targeting outreach to homeowners facing foreclosure requires local knowledge of subprime

lending patterns and methods of reaching the most vulnerable neighborhoods.

       There is also a place for central actors to provide resources, training, and standard

procedures – all of which benefit from economies of scale. The federal government’s grants for

local foreclosure counseling have been crucial in providing resources for counseling in hard-hit

localities. The federal government has also assured quality control through training and

certification that has increased trust toward foreclosure counselors. The Obama

Administration’s Making Home Affordable program is well-structured. By providing a common

set of procedures for modifying loans it helps overcome the ad hoc quality that characterized

early loan modification efforts. It even establishes a net present value (NPV) calculation that

should make the decision making transparent as to whether a loan should or should not be

modified.
32


        However, the resources for counseling, standard procedures, safe harbor legal

protections, and incentives for servicers have simply not been enough to break through the

perverse incentives of the servicers and rigidities in the PSAs.69 Decisions about which loans to

modify have been pulled out of the hands of knowledgeable local actors and placed in the

hands of national servicers who lack the expertise and the local knowledge to act effectively.

The hands of the counselors have been tied by “hyperrigid” national servicers. Local

foreclosure counselors report that servicers are difficult to contact, lack proper training, lose

paperwork, and delay decision making. The NPV calculation, which is supposed to be

transparent, can in fact be manipulated by servicers who can put higher recidivism rates and

other debatable data into the formula thus reducing the net present value of a modification.70

Just as the authority to regulate predatory lending was pulled out of the hands of local actors

and given to state and federal governments, decision making authority to modify mortgages

has been pulled out of the hands of local decision makers (public and private) and given to

national servicers who are insulated from public accountability by private contracts. Once

again, local actors have responsibility for the consequences of foreclosures but little authority

over them.

The Fog of Foreclosures: Data and Local Empowerment

        If my analysis of the foreclosure challenge is correct, interventions need to be targeted

in time and space. We need to act as early in the process as possible before subprime loans

have forced people out of their homes. Second, we need to concentrate our efforts on weak

69
   So-called cram-down legislation that would enable courts to include mortgages in bankruptcy proceedings would
probably help to motivate servicers.
70
   I would argue that the decision of whether to modify a loan should not just rest on whether it is beneficial to
investors but should take into account the costs to society as well.
33


market areas with concentrated foreclosures which can “tip” vulnerable neighborhood into

processes of contagious abandonment that destroy accumulated place-based assets. For these

reasons, information on the timing and location of the foreclosure is necessary for effective

local interventions. Information is not sufficient for effective responses, which also require

adequate resources, administrative capacity, and political will. In this section I argue that

federal and state policies concerning data are crucial to resilient responses. Without

standardized and sophisticated data, local actors are often in a “fog” – groping forward and

guiding action based on incomplete and inconsistent data. I will only make a few observations

about neighborhood stabilization in the wake of foreclosures; it is simply too large a topic to

cover here. But the following analysis of data and public policy provides an exemplar of central-

local relations that can be extended to the foreclosure policy system more generally.71




                                           Foreclosure         Sheriff’s   New Owner
       Loan             Delinquency                                                 Vacancy    Abandonment
       Origination                         Notice              Sale         REO
                                                                                    REO Sale




                                     Figure 4. The Stages of Foreclosure
71
     I rely heavily in this section on the insights of Newman (2010).
34




           The foreclosure challenge is a complex process that rolls out over time and space.

Figure 4 shows nine possible data points over time. There are many more. After a REO sale, for

example, local actors need to know whether the property was bought by an owner-occupier, a

local housing nonprofit, a local investor, or a national speculator. The foreclosure challenge is

constantly changing so responders need up-do-date data to adjust their policy responses to

constant change. If we know the location and timing of different kinds of loans, we can

anticipate foreclosure trends. Subprime loans began to reset to higher interest rates in two

years but Alt-A loans often had resets of about five years. To anticipate when neighborhoods

will be hit with more delinquencies and foreclosures, we need to know how many Alt-A loans

were originated and when they will reset. We also need to be able to disaggregate the data to

small geographies. Housing markets are local and processes of contagious abandonment are

very local. Research has shown that foreclosures damage property values in a circle with a

radius of about 1/8th of a mile or 660 feet. In order to track the spillover effects of foreclosures

we need data at the census tract level and smaller – even down to the block or parcel level.

           Good data is essential for bringing the issue to the attention of the public and placing it

on the policy agenda. Kermit Lind called local CDCs “the canary in the mine.” 72 However,

stories of individual suffering are not enough. CDCs are viewed as having a stake in magnifying

the problem. A more objective way to document the problem is needed. As Deborah Stone

has observed, “The process of counting something makes people notice it more….”73 In metro

area after metro area, counting foreclosures, showing their growth over time and spread across

72
     Lind (2008, p. 240).
73
     Stone (1998, p. 187).
35


the region has been crucial in garnering public attention. GIS maps can be visually arresting. In

St. Louis advocates used “heat maps” of foreclosures to show that the problem is spreading

across the city boundary to the suburbs.

       Just counting foreclosures is difficult because of data inadequacies. National data on

subprime lending was not collected until 2004 when HMDA reporting was expanded to include

information on high-cost loans. In retrospect, this data was crucial in putting the issue before

the public and making the connection between subprime loans and foreclosures. This data,

however, does not include ARMs and does not tell who originated the loan -- among other

flaws. Data on completed foreclosures is even weaker. Because the foreclosure process is

regulated by the states, the process varies and the data recorded is often not comparable. In

order to get meaningful data, a great deal of labor-intensive cleaning and compiling of data is

necessary. Lacking a national data depository on foreclosures, the private sector has stepped

in. RealtyTrac is a private firm that is often relied upon for foreclosure counts, but its data is

notoriously uneven and unreliable. Local actors frequently use it anyway because it is free.

McDash Analytics, now Core American Logic, has compiled much more accurate data but it is

very expensive. One of the major reasons why local actors often operate in a “fog of

foreclosures” is because mortgages and foreclosures are essentially a private transaction and

public access to meaningful data is often blocked.

       Good data is also needed after loan origination in order to prevent people from going

into foreclosure and being forced from their homes. Research has shown that contacting

people early in the process facilitates better outcomes. Probably because of the stigma of

foreclosure, people often do not take action to avoid foreclosure by talking to their servicer or
36


seeking counseling. As a result, it is important to reach out to people who are facing

foreclosure. In order to do this, counseling agencies need data on where loan delinquencies

are concentrated. Thus, for example, it would be useful to have data on loan delinquencies as a

precursor to a foreclosure notice. The Mortgage Bankers Association conducts a survey of

mortgage delinquencies but it is not disaggregated to small geographies to be useful to

foreclosure counseling agency outreach efforts.

           Later in the process it would be very useful if foreclosure counselors had information on

how servicers conduct their net present value (NPV) calculations. If counselors knew how this

calculation was made, they could concentrate their energies on clients who had a good chance

of having their loan modified. The purpose of the NPV calculation under the Obama

Administration’s HAMP program is to standardize the loan modification process and make it

transparent. Unfortunately, the NPV calculation is far from standard and transparent. Large

servicers, whose servicing book value exceeds $40 billion, may use their own default and

redefault rates and they do not have to publicly defend them. Even smaller servicers have the

right to adjust the standard discount rate set by the federal government, up to 2.5 percentage

points, which can have a huge effect on whether a loan should be modified or not.74 Housing

counselors report that they do not understand how the NPV calculations are made for their

clients. They are operating in a fog.75

           Data is equally important in the post-foreclosure process. Here, once again, the fog can

be thick. Data on the number and duration of REO properties is an excellent indicator of

market recovery. The accumulation of REO properties in specific areas indicates a weak market

74
     Cordell et al (2009, p. 28).
75
     Winter and Swanstrom (2010).
37


and possible contagious abandonment. Dan Immergluck, one of the most active researchers on

foreclosures, states the problem bluntly: ”Data on foreclosures and post-foreclosure

properties, such as REO, are not compiled on a regular, uniform bases by any public agency at a

multistate level.”76 Forced to use a private national data base, Immergluck identified that REO

properties tend to accumulate in central cities in weak market metros but in strong market

metros REOs have accumulated in distant “drive-‘til-you-qualify” suburbs. After a property is

sold out of REO, local governments often do not even know who owns it and therefore they

cannot hold the owner accountable for basic costs – such as grass cutting or board up of vacant

properties. Vacancy data would also be very useful in determining which neighborhoods are

vulnerable to contagious processes of abandonment and decay. The United States Postal

Service has data on vacancies but it has many flaws.

           The federal government’s Neighborhood Stabilization Program (NSP) requires extensive

data and skillful data analysis in order to be effective. The small size of the program relative to

the need makes strategic targeting of the program all that much more important. Originally

funded at 3.92 billion nationwide, a second phase of competitive grants (NSP2) received an

additional $1.92 billion . This money was slated to be primarily used to buy foreclosed

properties, fix them up, and put them back on the market. To give an idea of the gap between

resources and need, St. Louis County received a total of $16.5 million ($9.3 as a direct allocation

from the federal government and $6.2 million allocated from the State of Missouri). This is

enough money to do 100 properties at $100,000 per home – in a county which had over 4,000

completed foreclosures in 2009. This means the funds could treat less than 2.5 percent of the


76
     Immergluck (2008, p. 3)
38


foreclosed properties.77 Spreading the funds around, the so-called peanut-butter approach,

risks wasting taxpayer’s money when rehabilitated homes are overwhelmed by market

dynamics.

        The logic of NSP targeting is clear: funds should be concentrated on “transitional”

neighborhoods where foreclosures could tip a previously stable neighborhood into decline.78

This is where the negative spillovers of foreclosure can mount and where policy can get the

biggest bang for the bucks. Identifying transitional neighborhoods is not an easy task. The

Reinvestment Fund in Philadelphia has pioneered using cluster analysis to identify transitional

neighborhoods.79 This requires collecting a wide range of housing data at the block group or

neighborhood level. A statistical analysis is then performed (cluster analysis) to identify which

neighborhoods are performing similarly. Neighborhoods can be arrayed from the strongest to

the weakest, with transitional areas in the middle. Cluster analysis requires a wide array of

parcel-based data and a skilled analyst. The technique is not automatic. It requires knowledge

of local markets in order to identify the number of clusters and final results must be evaluated

in the context of developments not captured by the data, such as where a new school or

grocery store is being built. The obstacles here are both the availability of the data, some of

which must be procured from county assessors who often are technologically backward and

refuse to allow public access to the data.

        It worth reiterating that just doing good data analysis is not enough. Targeted funding

must overcome what Anthony Downs called the “law of political” dispersion –the tendency to

77
   Of course, if the properties are sold the NSP funds can be recycled so that more properties can be helped over
the long run.
78
   See Goldstein (2008) and Mallach (2008).
79
   Goldstein & Closkey (2006).
39


spread funds around to enough ward or political jurisdictions to create a minimum-winning

coalition.80 Not only may it make political sense to spread some of the funding around, the

analysis also suggests a rationale for spending funds outside transitional neighborhoods. There

are appropriate strategies and legitimate uses of funds in very strong and weak market

neighborhoods beset by foreclosures: strong market neighborhoods would benefit from

increased housing code enforcement to make sure that foreclosed properties do not create

visual blight and weak market neighborhoods would benefit from land banking and rightsizing

to set the stage for future market recovery.

           Under the leadership of the Northeast Ohio Community and Neighborhood Data for

Organizing (NEO-CANDO) at Case Western Reserve University, the Cleveland metropolitan area

has developed one of the best data collection and analysis systems in the nation. NEO CANDO

gathers neighborhood data for 17 counties in Northeast Ohio and makes it available to the

public on its website. Established in 1992, NEO CANDO has a wide support from area

foundations and played a key role in the rethinking of community development in Cleveland

from a bricks and mortar orientation to one focused strategically on fortifying markets in a

handful of transitional neighborhoods. Neighborhood Progress Inc. has developed a Land

Assembly Project that targets funds to six CDCs to create “neighborhoods of choice”. Cuyahoga

County’s application to the federal government for Neighborhood Stabilization Program funds

supports this strategy.

           The sophisticated regional data system in Cleveland is more the exception than the rule.

This is because under the present rules of the game developing a sophisticated regional data


80
     Downs (1980, p. 530).
40


system is expensive, labor-intensive, and politically challenging. The first problem is that the

private nature of foreclosure data and the fragmented collection of parcel-level data at the

state and county level means that every metropolitan area must reinvent the wheel, cleaning

and organizing the data in an expensive and time-consuming process. Because there is no

profit in doing it, creating a regional data utility requires significant public or foundation

funding. Moreover, much of the parcel-level data is controlled by county assessors who are

concerned about tax rates and assessment practices, not public policy. Many are underfunded

and the data is not digitized, requiring laborious hand entry. Some counties sell the data.

Acquiring access to this data at a reasonable cost and on a regular basis requires cutting

political deals that must be negotiated with each county.81

         The solution to the problems of data on foreclosures is a policy of “targeted

transparency.”82 According to the originators of the concept, targeted transparency policies

include five characteristics:

        Mandated public disclosure

        By corporations or other private or public organizations

        Of standardized, comparable, and disaggregated information

        Regarding specific products or practices

        To further a defined public purpose.83




81
   Newman (2010).
82
   Fung, Graham & Weil (2007).
83
   Fung, Graham & Weil (2007, p. 6).
41


When problems are widely dispersed or locally variable a policy of targeted transparency may

make more sense than government regulation. Government acts as “stewards of transparency

policy by compelling disclosure of needed information when participants cannot obtain it,

fostering common definitions and accurate metrics, and providing feedback and analysis to

encourage transparency improvement.”84

        The originators of the concept cite the 1975 Home Mortgage Disclosure Act (HMDA) as a

successful example of targeted transparency. Motivated by fears of redlining and

discrimination in lending, HMDA required federally regulated lenders to report on the loans

they made by census tract; late they were required to report on the race of applicants and loan

recipients. The 1977 Community Reinvestment Act (CRA) required regulated lenders to “meet

the credit needs of their communities.” Advocates of “targeted transparency” stress that the

information needs to be embedded in the decision making routines of organizations.

Community-based organizations used HMDA data to challenge the banks and during the formal

period of the challenge the lending institution was prohibited from merging or opening new

branches. In order to avoid negative publicity and stop the challenge, banks often cegotiated

community lending agreements in which they agree to lend to low-income and minority

neighborhoods. According to the National Community Reinvestment Coalition between 1992

and 2000 the value of CRA agreements totaled $1.09 trillion.85 A study by the Federal Reserve

concluded that CRA opened up new profitable business opportunities for banks and CRA loans

generally performed as well as non-CRA loans.86


84
   Fung, Graham & Weil (2007, p. 17).
85
   Community Reinvestment Coalition 2001; as cited in Fung, Graham & Weil (2007, p. 251).
86
   Board of Governors of the Federal Reserve System (2000); as cited in Fung, Graham & Weil (2007, p. 252).
42


        HMDA, originally designed to address the problem of redlining, could be reformed and

expanded to address the problem of greenlining. First, HMDA needs to be extended from

federally regulated institutions to all mortgage lending. Data needs to be reported in a

common format and standardized way to track mortgage lending from loan origination to REO

sales so that it can be disaggregated to small geographies, preferably census tracts or smaller.

In addition, data should be reported in real time so that actors can keep pace with fast-

changing trends. The internet enables data to be shared almost instantaneously with users. In

addition, HUD should work to require county assessors to share parcel-level data in a

standardized and digitized form. There is no reason why every county in every state should

record and store data in different ways. HUD could condition grants on developing statewide

common property reporting requirements. In order to facilitate digitizing data HUD should

consider competitive grants to states or county assessors.87

        Once the necessary data is made available in a common format and on a timely basis

there still is the problem of regions developing the capacity to analyze and manipulate the data

in meaningful ways. Regional data clearinghouses, like NEO CANDO, have developed in

metropolitan areas across the country, usually led by universities. Community foundations

have played a key role in developing regional data clearinghouses. However, many regions lack

strong community foundations. National organizations like the National Vacant Property

Campaign, the National Neighborhood Indicators Project, and Living Cities have played the role

of national intermediaries in promoting regional data capacity, but capacity varies


87
  HUD will also need sophisticated regional data system to evaluate NSP grants. This will require an understanding
of the NSP interventions and an analysis of housing market dynamics that will enable researchers to isolate policy
effects from normal neighborhood trajectories. See Kingsley, Smith & Price (2009, p. 43).
43


tremendously across regions. HUD should consider start-up grants for regional data

clearinghouses. Modest amounts of money could leverage large increases in technical and

analytical capacity.

Conclusion: The Lessons for Central-Local Relations

          Foreclosures are the new urban renewal. Once again, millions of people are being

displaced, roiling the social structure and increasing social tensions. This time, however,

instead of government, the private sector is taking the lead and decision making processes are

much more diffuse. The particular challenge of foreclosures places is that they can destabilize

the balance between supply and demand for housing, setting in motion reinforcing processes of

neighborhood decline that wipe out place-based social, physical, and financial assets. The

nature of the foreclosure challenge requires that it be addresses as early as possible and that

interventions be targeted on concentrated foreclosures in weak market areas. He tragedy of

the foreclosure crisis is that early and targeted interventions were hobbled by existing federal

and state policies.

          The most effective action by local actors would have been to intervene early in the cone

of causality, stopping subprime lending before it locked homeowners into unsustainable

mortgages. As we saw, however, preemption of local action by states, preemption of state

antipredatory policies by the federal government, and a race-to-the-bottom by federal

regulators gutted effective regulation of subprime lending, the root cause of the foreclosure

crisis.

          Local housing nonprofits were in many ways resilient in responding to the threat of

foreclosures from subprime lending -- shifting employees, expanding organizational repertoires,
44


mobilizing new resources, and establishing innovative partnerships with public and private

organizations. Aided by federal NFMC grants local foreclosure counseling agencies have been

able to facilitate loan modifications and keep some families in their homes. However, rigid

policies by servicers and PSAs that serve almost as suicide pacts have prevented foreclosure

counseling from scaling up to address the magnitude of the problem.

        Finally, faced with the mounting spillovers from completed foreclosures local actors

have struggled to cope, but they lack the data and the analytical capacity to identify transitional

neighborhoods where intervention could make the biggest difference, the resources to change

market dynamics, and often the civic and administrative capacity to implement sophisticated

multi-sectoral and cross-silo revitalization policies.

        According to a recent Pew Research Center Survey, “Americans are more skeptical of

Washington than ever.”88 Even in wake of the foreclosure crisis and the abuses on Wall Street

public opinion has shifted toward wanting a smaller government with fewer services. Clearly,

we need strong federal regulations to prohibit predatory lending practices across-the-board.

But we also need to shape federal policies that empower local actors to solve their own

problems. Even though positive perceptions of the personal impact of local governments on

their daily lives are down, a majority (51 percent) still view local government’s impact as

positive compared to only 38 percent for the federal government.89 In this paper I have

discussed how the federal and state governments can support resilient local responses to the

foreclosure crisis. First, we need to give local governments the home rule powers to regulate


88
  Kohut (2010).
89
  Pew Research Center Survey available at: http://pewresearch.org/pubs/1569/trust-in-government-distrust-
discontent-anger-partisan-rancor.
45


mortgage lending that can have huge negative spillover effects within their borders. Effective

responses to foreclosures also require supportive state and federal policies. Higher level

governments need to provide the infrastructure, like interstate highways and water mains,

leaving it to local governments to connect the feeder roads and the water spigots. Standard

information and uniform reporting practices may appear to centralize power in the hands of

federal bureaucrats but, in fact, they create transparency and help to empower local actors.

Lacking supportive state and federal policies, local actors will never be able to bring their

resilient responses up to scale. Far from taking power away from local actors, more vigorous

federal and state policies can empower localities and enhance democratic accountability.
46


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