All the talk about trying to prevent foreclosures highlights the inability of policy makers to distinguish between "means" and "ends". Foreclosure is the means by which properties get transferred from those who can't afford them to those who can.
There is a societal interest in avoiding Foreclosed properties sitting around in certain areas. Our efforts should directed to that "end". Preventing foreclosures is one way to avoid foreclosed properties but it is unfocused and highly diffused- likely to cause as much damage as good, raises a whole host of questions of fairness and moral hazard. Instead we should be working on making the process that moves homes from those who can't afford them to those who can quicker and easier.
The most frequently cited argument for society's interest in preventing foreclosure is that the presence of a foreclosed property causes neighboring properties to lose value i.e. everybody loses and therefore it is o.k. to use tax payer funds to bail out lenders and borrowers from the consequences of their mistakes. This argument suffers from two broad deficiencies (a) it is not true in areas with large number of foreclosures and even more important (b) it hasn't worked! the latest findings suggest that negotiated loans are defaulting at very high rates.
(Many reasons for this high default rate have been suggested but one that has not been commented on (probably because it is politically incorrect) is that there are a large number of people who just don't have the financial skills or personal discipline to be home owners-they lack simple budgeting skills, the discipline to stick to a budget. Perhaps we are going to have to acknowledge that there is a limit to the level of home ownership based not on economic reasons but social skills.)
Communities have tipping points- when abandoned and foreclosed properties start an irreversible down trend in the broad community. It has been well documented that an intervention prior to the tipping point can reverse a down trend and local government that have attempted to do this have been rewarded by both stabilizing their tax base and from profits on the purchased properties once the neighborhood has been stabilized. However, once the tipping point has been passed additional foreclosed properties have diminishing impacts on property values-arguably there is a point when they have no impact. It follows from this that trying to prevent foreclosure in neighborhoods past the tipping point is a waste of money (considered at a societal level obviously to the individual borrower and lender it is not).
What would a policy that rather than preventing foreclosure seeks to facilitate the movement of properties from those who can't afford them to those that can? First and foremost it would require local governments to decide which neighborhoods can be saved and which can't. Other elements would be
A. Make available below market financing to allow people to purchase foreclosed properties in targeted areas. However, unlike traditional mortgages allow the subsidized financing to be transferred to qualified buyers on future resales.
B. Provide for some property tax abatement on the foreclosed property-local governments must have some skin in the game.
C. Consolidate neighborhoods. Home owners in neighborhoods that have gone past the tipping point but are current on their mortgages should be offered the opportunity to swap their homes with a foreclosed home in a targeted neighborhood and transfer their mortgage to the new property. The premise is simple- if you start with two neighborhoods each with a 50% foreclosure rate there is more value created by having one neighborhood with 100% foreclosure rate and another one with a 0% rate(aka the dumbbell investment strategy)
D. Local governments should be provided with funds to purchase foreclosed homes in targeted neighborhoods and convert them into rent to buy properties (tenants get the opportunity to purchase their homes at some point in the future).
E. Change the law so that homeowners can be converted into tenants without having to go through the eviction process.
What happens to the neighborhoods that are past the tipping point? Clearly the value of all homes will decline substantially. However, that will facilitate the conversion of those neighborhoods into different price points e.g. some of the housing could be converted into section 8 housing now possible because of the lower price points. This type of re-use absent consolidation wouldn't be possible since the existing homeowners would fight it tooth and nail.(I believe most developers would rather have a completely vacant property rather than one that is 20% occupied which limits their flexibility).
The worst possible out come both economically and morally is to leave a home unoccupied. (There is something particularly obscene that we have large levels of homelessness particularly amongst veterans while we have vacant homes;suggesting that our problem is price not quantity). In fact rather than provide a handout to the borrower or lender at tax payer expense I would rather that money and more was used to provide decent housing to veterans.