Economic Analysis of a Mortgage Foreclosure Moratorium

Economic Analysis of a Mortgage Foreclosure Moratorium

Order Code RL34653
Economic Analysis of a Mortgage
Foreclosure Moratorium
Updated September 12, 2008
Edward Vincent Murphy
Analyst in Financial Economics
Government and Finance Division

Economic Analysis of a Mortgage
Foreclosure Moratorium
Summary
On July 26, 2008, Congress passed legislation creating a voluntary program to
enable troubled mortgage borrowers and lenders to refinance their loans through the
Federal Housing Administration (FHA). Having created the voluntary program, it
remains to be seen if people will be willing and able to participate under current
financial market conditions. Meanwhile, the pace of foreclosures continues to rise,
even as another category of loans, Alt-A, approaches the peak of its payment resets.
The foreclosure process may be costly and cumbersome. Some have argued for a
moratorium on foreclosures to give distressed borrowers and lenders time to seek
financial relief. Others might argue that delaying foreclosures may also delay the
recapitalization of the banking system and ultimately delay restoration of stability in
financial markets. Proponents might counter that providing additional time to keep
current borrowers in their homes will ultimately reduce the magnitude of bank losses
and lessen the need for recapitalization.
The persistence of large unsold inventories of housing may be an indicator that
house prices may fall further. Further declines in house prices might contribute to
more foreclosures and more instability in financial markets. Although economists
generally believe that prices adjust to clear shortages and surpluses, it could be
argued that the housing market has characteristics that make that process longer and
more painful than in some other consumer goods markets. In housing markets,
several factors may contribute to a feedback loop (where housing market instability
becomes self-reinforcing). Potential obstructions to price adjustment and market
clearing in the housing market include builders hesitating to lower prices for new
houses because they may have duties to previous customers; the reluctance or
inability of some homeowners to sell their houses for less than they owe on their
current mortgages; the addition of foreclosures to housing supply when prices fall;
the tendency of some potential buyers to wait for market prices to hit bottom; and the
reduction of available mortgage credit during a housing market downturn.
A moratorium would have costs and benefits. On the benefit side, it would
provide all market participants with more time to assess asset prices and evaluate
alternatives. On the cost side, it could delay the ability of markets to clear excess
inventories and restore financial stability. Evidence from the Great Depression
suggests that states that enacted moratoriums provided relief to some home owners
but saw higher costs of credit and fewer loans compared with states that did not. It
nevertheless has been argued that natural disasters are an appropriate analogy and
that the oncoming schedule of Alt-A mortgage resets creates time pressure that, in
the absence of a moratorium, could overwhelm the capacity of loan servicers.
A regulatory foreclosure freeze has been announced by the FDIC for IndyMac
loans. Some have called for a foreclosure freeze for loans held by the GSEs in
conservatorship. In Congress, H.R. 6076 would set up a deferment period during
which home owners would make a payment calculated by formula.
This report will be updated as conditions warrant.

Contents
Background . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Economic Analysis of Delaying Foreclosure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
The Economics of Excess Inventories in the Housing Market . . . . . . . . . . . 3
Supply and Demand . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Attitude of Developers Toward Prior Home Purchasers . . . . . . . . . . . . 4
Nominal Mortgage Contracts, Inflation, and Sticky House Prices . . . . 5
Foreclosures and Unmanageable Resets Increase Supply . . . . . . . . . . . 6
Fence-Sitters, Potential Buyers May Wait for Prices to Bottom Out . . . 8
Financial Problems of Banks and GSEs Reduce Demand for Houses . 8
Uncertainty Affecting Housing Market Participants . . . . . . . . . . . . . . . . . . . 9
Loan Servicers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
Borrowers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
Lenders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
Foreclosure Moratoriums in Historical Perspective . . . . . . . . . . . . . . . . . . . 11
Great Depression . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
Natural Disasters . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
Other Examples . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15

Economic Analysis of a Mortgage
Foreclosure Moratorium
Background
On July 26, 2008, Congress passed legislation creating a voluntary program to
enable troubled mortgage borrowers and lenders to refinance their loans through the
Federal Housing Administration (FHA).1 Having created the voluntary program, it
remains to be seen if people will be willing and able to participate under current
financial market conditions. Meanwhile, the pace of foreclosures continues to rise,
even as another category of loans, Alt-A, approaches the peak of its payment resets.2
The foreclosure process may be costly and cumbersome.3 Some have argued for a
moratorium on foreclosures to give distressed borrowers and lenders time to seek
financial relief. Others might argue that delaying foreclosures may also delay the
recapitalization of the banking system and ultimately delay restoration of stability in
financial markets. Proponents might counter that providing additional time to keep
current borrowers in their homes will ultimately reduce the magnitude of bank losses
and lessen the need for recapitalization.
There have been calls to delay or freeze mortgage foreclosures. H.R. 6076, the
Home Retention and Economic Stabilization Act of 2008, was introduced by
Representative Matsui on May 15, 2008.4 This bill would grant delinquent subprime
and negative amortization borrowers up to an additional 270 days prior to
foreclosure. On the regulatory side, the FDIC has announced that it will halt
foreclosures for loans that it administers through its supervision of IndyMac Bank,
which recently failed.5 Some have reportedly called for the recent conservatorship
1 Passed as H.R. 3221, Housing and Economic Recovery Act of 2008, and enacted as P.L.
110-289 on July 30, 2008. See CRS Report RL34623, Housing and Economic Recovery Act
of 2008, by N. Eric Weiss, Darryl E. Getter, Mark Jickling, Mark P. Keightley, Edward
Vincent Murphy, and Bruce E. Foote.
2 See CRS Report RL33775, Alternative Mortgages: Causes and Policy Implications of
Troubled Mortgage Resets in the Subprime and Alt-A Markets, by Edward Vincent Murphy.
3 See CRS Report RL34232, Understanding Mortgage Foreclosure: Recent Events, the
Process, and Costs, by Darryl E. Getter, discussing estimates of foreclosure costs.
4 See CRS Report RS22943, H.R. 6076: Home Retention and Economic Stabilization Act
of 2008, by Edward V. Murphy.
5 Federal Deposit Insurance Corporation, “Loan Modification Program for Distressed
Indymac Mortgage Loans,” press release, August 20, 2008, available at
[http://www.fdic.gov/consumers/loans/modification/indymac.html].

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of Fannie Mae and Freddie Mac to freeze foreclosures for the loans that these
institutions hold.6
Economic Analysis of Delaying Foreclosure
Delaying foreclosure could have benefits. Borrowers who may not have fully
prepared for payment increases built into their mortgages would have more time to
adjust their household finances. They would also have more time to consider
participating in the newly enacted voluntary program to refinance loans into FHA at
reduced principal, if their lenders agreed. Similarly, lenders would have more time
to consider loan modification, or participation in the new FHA program, as a loss-
minimizing alternative to the costly foreclosure process, especially considering the
decline in the value of houses, which serve as collateral for the loans. Other home
owners trying to sell their homes would not have to compete with quite so many
foreclosure sales, which often drive down prices. Neighborhoods and communities
might be able to slow the growth of concentrated pockets of vacant and poorly
maintained homes, which sometimes become magnets for accidents, crime, and even
breeding grounds for disease carrying pests.7
The benefits for some of a delay could come at a cost to others. Renters who
may desire to purchase a home but were priced out during the previous housing boom
might have fewer opportunities than they would without a foreclosure deferment
program. Some banks, who are already experiencing liquidity and solvency
problems, would lose at least one potential avenue of recapitalization (selling the
collateral of under-performing loans). It is possible that a deferment plan could
simply delay the bottoming out of the housing market and extend the period of large
unsold housing inventories, in which case potential buyers who are waiting for prices
to trough might remain on the sidelines. If the return of potential home buyers were
delayed on a large scale then it would be possible that mortgage markets and related
financial institutions might remain in turmoil for an extended period, disrupting the
financing of student loans, auto leases, municipal funding, and other seemingly
unrelated markets.
Trade-offs, such as the potential benefits and costs of foreclosure deferment, are
central to the economic approach. Although competitive markets are said to allocate
resources efficiently (under certain assumptions), the persistence of large unsold
6 “Democrats call on Fannie, Freddie to halt foreclosures,” Los Angeles Times online,
September 12, 2008, available at [http://www.latimes.com/business/la-fi-fannie12-2008sep
12,0,1383031.story].
7 Reportedly, vacant homes with pools that have not been maintained have become breeding
grounds for mosquitos capable of carrying viruses. Blair Robertson, “Mosquito District
Treats more Abandoned Pools: Homeowners in Foreclosure or Who Feel Financially
Squeezed are a Likely Factor as Workers Fight West Nile Transmission,” Sacramento Bee,
July 8, 2008, p.B3.

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inventories of houses is not consistent with a market in equilibrium.8 Rapid declines
in house prices have not as yet drawn buyers back in on a large scale. In economic
theory, the ability of private actors to effectively evaluate trade-offs and reach
efficient outcomes depends upon transaction costs, the availability of relevant
information, and the presence of competing buyers and sellers.9 These theoretical
conditions for economic efficiency can be useful for diagnosing potential obstacles
to private bargaining solutions.
The central trade-off in evaluating a deferment is the cost and benefits of
quickly moving the ownership of assets from distressed hands to secure hands. Many
observers recognize that delays in reallocation has opportunity costs: at least some
of the policy considerations in bankruptcy are intended to facilitate this asset transfer
and minimize the costs of delay. But economists recognize that speed itself has
costs; for example, two researchers of financial crises have observed that “... speed
can actually work against a well-functioning procedure if time is required to properly
assess the value of assets and claims, allow for negotiations, search for potential
bidders, and generally increase the liquidity of the bidding process.”10 From an
economic perspective, analysis of a moratorium on foreclosures in the current
housing cycle focuses on the factors that could affect the speed of reducing the
inventory of unsold homes, including the uncertainty faced by market participants.
The Economics of Excess Inventories in the Housing Market
In a relatively free market, prices are expected to adjust up or down to eliminate
surpluses and shortages. Persistent surpluses, such as excess inventories of unsold
homes, are often a sign that quantity supplied at the current price is greater than
quantity demanded. In the current housing market, the inventory of unsold homes
in many formerly appreciating markets is far above the historic average, an indicator
8 The National Association of Realtors reports that the unsold inventory of homes, expressed
as the number of months required to sell all homes for sale at the current sales pace, is above
11 months supply. A more normal supply would be five to six months. Available at
[http://www.realtor.org/press_room/news_releases/2008/ehs_down_in_june].
9 More formally known as the Coase Theorem, private bargaining is likely to reach
economically efficient outcomes when property rights are well defined, transaction costs are
zero, all necessary information is available, and prices reflect opportunity costs (as in
competitive markets). Economic efficiency is usually defined as the state in which it is no
longer possible to rearrange resources to make one person better off without making
someone else worse off (Pareto Standard), or alternatively efficiency is when all possible
moves in which the gains to winners are larger than the losses to losers are taken advantage
of (Kaldor-Hicks Standard).
10 David Smith and Per Stromberg, “Maximizing the Value of Distressed Assets: Bankruptcy
Law and the Efficient Reorganization of Firms,” Chapter 8 of Systemic Financial Crises,
Patrick Honohan and Luc Laeven editors (Cambridge: Cambridge University Press, 2005),
p. 271.

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that prices could fall further.11 The expectation of further price declines could itself
discourage new buyers and delay the restoration of more normal conditions.
Supply and Demand. The recent fall in house prices in formerly booming
areas was not a random event that no one could have predicted; rather, a period of
rising prices followed by a period of falling prices is the expected economic outcome
when demand for a good rises and suppliers are delayed in their ability to respond to
the increased profits (although it is often difficult to determine the timing and
magnitude of price changes). That is, the increased demand initially bids up prices
and increases producer profits, but eventually producers are able to increase capacity.
Prices are then expected to fall back to reflect producer costs. This basic supply and
demand approach is consistent with the recent experience of many formerly booming
housing markets, including in Florida, California, Nevada, and Arizona. That is not
to say that the housing market does not have various features that affect the speed by
which house prices reduce shortages and surpluses; for example, producers must
comply with zoning restrictions, and home purchasers are typically restricted by the
availability of mortgage credit.
From an economist’s point of view, the good news is that we do not have to wait
for a random shock for the housing market to recover; rather, the market is expected
to recover as (1) producers reduce construction (which has already happened in many
areas), (2) normal demographic household formation increases the number of
potential home purchasers, and (3) price declines bring affordable home ownership
within the reach of a greater percentage of an area’s population. The combination of
fewer housing units for sale and more potential home buyers will eventually stabilize
the housing market. From the point of view of many policymakers, however, the bad
news is that this process may take longer, and the amount of dislocation caused may
be greater, because of several features of the mortgage market — features that may
be subject to amelioration. Five factors may tend to prolong surpluses of unsold
homes and delay the stabilization of housing markets: builder attitudes toward prior
home buyers, nominal mortgage contracts, foreclosure supply feedbacks, potential
buyers waiting for prices to bottom out, and financial problems of the providers of
mortgage funds, such as banks and government-sponsored enterprises (GSEs). A
moratorium on foreclosure could potentially address some, but not all, of these
factors.
Attitude of Developers Toward Prior Home Purchasers. Home
builders who develop large neighborhoods are often reluctant to lower prices because
this can anger earlier buyers. Rather than lower the asking price of the home, the
builder might prefer to offer other incentives, such as reduced financing costs or
discounted options (such as granite countertops or a jacuzzi tub). Because builders
may raise prices when conditions allow but seek alternatives to recording price
declines when conditions are reversed, a period of slowing sales may occur rather
than a period of falling prices. As a result, potential buyers may not know that the
11 The National Association of Realtors report 11 months supply. Available at
[http://www.realtor.org/research/research/ecoindicator]. Note the emphasis on the term
“excess” inventory; the existence of at least some unsold inventory can be a healthy sign
because it means consumers have a variety of choices.

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real cost of homes has fallen into their price range and other sellers (such as owners
of existing homes) may not realize that they will be unlikely to find a buyer if they
do not lower their asking price. This reluctance of builders to lower asking prices
was observed earlier in the housing cycle but many builders have since capitulated.

In the current housing cycle, builder reliance on financing incentives and
construction options rather than price reductions is probably no longer a significant
obstacle to the clearance of unsold inventories. Builders began aggressively cutting
prices and trying to clear their own inventories in many areas earlier in the housing
cycle. Builders have also reduced new construction, as measured by housing starts,
and have cancelled, or failed to exercise, many of their options on land for
development. A moratorium on foreclosures would be unlikely to affect the
incentives of builders to try to avoid lowering asking prices.
Nominal Mortgage Contracts, Inflation, and Sticky House Prices.
Prices that are not adjusted for inflation are called nominal prices. The vast majority
of mortgages do not directly adjust the monthly payment for changes in the inflation
rate. Because the United States has generally experienced inflation since World War
II, most Americans have had the real (as opposed to nominal) price reflected in their
monthly mortgage payment decline over time. Similarly, inflation has masked
periods of declining real house prices. Nominal house prices continued rising in
some areas even though the real prices of houses declined once inflation was taken
into account. In individual cities, even nominal house prices had been known to fall,
sometimes sharply. The claim that the United States as a whole has not experienced
a house price decline is not true for real house prices.
The distinction between nominal and real prices is important. First, some
Americans may have been overconfident that the price of their home would never
decline. As a result, they may have accepted mortgage terms that would commit
them to refinancing their houses quickly even if they could only do so if house prices
continued climbing. Consistent with this analysis, the use of mortgages with low
down payments and low introductory monthly payments is concentrated in areas that
formerly had rapid price appreciation. Now the default and delinquency rate on these
loans, for all classes of borrowers, has risen significantly. The wave of payment
resets caused by the expiration of these introductory periods in areas in which the
expected appreciation did not occur is one of the reasons that some policymakers
wish to quickly facilitate mortgage refinances.

The second reason why the nominal mortgage contract is important is because
it may create an obstacle to clearing the unsold housing inventory. A homeowner
who cannot make the current monthly mortgage payment can avoid foreclosure by
selling the house as long as there is positive equity in the home. Falling house prices
reduce the homeowner’s equity; in some areas prices have fallen enough that many
recent home purchasers, even prime borrowers, now have negative equity. A person
cannot sell his or her home to avoid foreclosure if he or she does not have adequate
equity or sufficient savings to pay off the current creditor and any other selling costs,
such as the real estate agent. Unless the lender agrees to accept less than the amount
owed on the original loan (e.g., a short sale), there is a nominal price floor below
which these homeowners cannot go — a price floor prolongs an economic surplus,
such as the inventory of unsold homes. Historically, it was common for distressed

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debtors to advocate for greater inflation, which is consistent with a desire to lower
the real price when it is difficult to lower the nominal price.
A moratorium on foreclosures could affect nominal mortgage contracts because
it would increase the length of time that inflation can affect real house prices. That
being said, the current inflation rate is significantly below the magnitude that is
probably necessary to lower real house prices enough that prospective buyers could
meet many sellers’ nominal price floors. The inflation rate as measured by the
consumer price index from July 2007 to July 2008 was 5.6%, which is significantly
less than nominal price declines in some areas.12 For example, the nominal price
decline for San Francisco measured by the Case Schiller home price index from May
2007 to May 2008 was -23%.13 If inflation is included, the real price declined even
further. Another example, from an alternative measure of housing prices from the
Office of Federal Housing Enterprise Oversight (OFHEO), which is generally less
volatile than the Case Schiller index, reported a nominal price decline in Sacramento,
CA, of -13.2%.14 Because it would take two to three years for the current rate of
inflation to compensate for even one year’s nominal price decline in some areas, it
is unlikely that a brief moratorium on foreclosures would significantly reduce that
part of the impediment to equilibrium that is caused by the use of nominal prices in
mortgage contracts.

Foreclosures and Unmanageable Resets Increase Supply. There are
some problems in housing markets that create a feedback loop that can increase the
number of homes being offered for sale when prices are falling. In areas where the
direction of prices unexpectedly switches from rising to falling, for example, people
who counted on further price appreciation to enable them to refinance their homes
on more favorable terms will be frustrated, and some may try to sell their homes to
avoid foreclosure.15 Price reductions also increase the number of home owners who
owe more than their home is worth, especially if there have been a large number of
buyers who put little or nothing down. The combination of home owners who cannot
afford a scheduled increase in their monthly mortgage payments and those who no
longer have sufficient incentive to continue paying down a loan because their
negative equity is large (more than $100,000 in some areas) tends to increase the
number of homes offered for sale in precisely those areas that once had rapid price
increases but are now experiencing rapid price declines. Although the peak period
of payment resets for subprime mortgages reportedly is passing, other mortgages with
a reset feature (e.g., so-called Alt-A and Hybrid ARMs) that are even more highly
12 Unadjusted twelve month calculation, Bureau of Labor Statistics, July 2008, available at
[http://www.bls.gov/news.release/pdf/cpi.pdf].
13 Calculated from May 2007 to May 2008 from Standard and Poor’s Case Schiller Price
Index, availabl e at [ ht t p: / / www2.st andar dandpoors.com/spf/pdf/index/
CSHomePrice_History_072943.xls].
14 Calculated from OFHEO’s house price index data from first quarter 2007 to first quarter
2008, not seasonally adjusted, available at [http://www.ofheo.gov/media/hpi/
1q08hpi_cbsa.csv].
15 See CRS Report RL33775, Alternative Mortgages: Causes and Policy Implications of
Troubled Mortgage Resets in the Subprime and Alt-A Markets, by Edward Vincent Murphy.

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concentrated in formerly rapidly appreciating regions will be triggered in 2008, 2009,
and 2010.16 The net result is that falling house prices can also increase supply (over
some range) through a feedback process between negative equity and default rates.
A foreclosure moratorium may, under some circumstances, help to reduce the
supply feedback effect of falling house prices. In the short run, it would slow down
the number of distress sales in the marketplace and reduce the downward pressure on
prices. Because foreclosure sales also affect the existing homeowners’ perceptions
of the value of their own homes, it could be argued that foreclosure sales increase the
incentive of people to choose to default opportunistically when their negative equity
is high.17 On the other hand, negative equity is a necessary but not a sufficient
condition for foreclosure (because a pre-foreclosure sale can avoid default if there is
positive equity). One study of borrowers in Massachusetts with negative equity in
the 1990s, for example, found that more than 90% retained their homes, suggesting
that opportunistic default may be overstated in some cases.18
A moratorium might also allow households that have unmanageable payment
resets to adjust their household finances. Eligible families may be able to refinance
into a more affordable loan or negotiate new terms with their existing creditors,
perhaps by taking advantage of the new FHA program.19 Some people who used
mortgages with low introductory payments and were surprised when house prices
failed to continue appreciating would have time to adjust both their expenses and
their earnings. Household earnings can be raised in some cases, for example, by
having a family member return to work or by renting a room to a boarder.20 In some
cases, there may be a delay between realization that a payment reset will be
unaffordable and the family’s ability to adjust earnings and expenses.
The effect of a moratorium on the supply feedback of foreclosures and
unmanageable resets is hard to project. On the one hand, a delay in foreclosure is
unlikely to reduce the incentive of people with large negative equity to
opportunistically default. If these people will eventually default anyway then a
moratorium merely delays the inevitable and extends the period of destabilizing
unsold inventories. On the other hand, a delay in foreclosure could provide those
families whose expectations of market conditions were frustrated and now face a
16 Christopher Cagan, “Mortgage Payment Reset,” Presentation at the Real Estate Research
Council of Southern California, May 30, 2007, available at [http://www.csupomona.edu/
~rerc/RERCSC%20Chris%20Cagan%205.30.07.pdf].
17 See CRS Report RL34232, Understanding Mortgage Foreclosure: Recent Events, the
Process, and Costs, by Darryl E. Getter.
18 Christopher L. Foote, Kristopher Gerardi, and Paul S. Willen, “Negative Equity and
Foreclosure: Theory and Evidence,” Federal Reserve Bank of Boston, Working Paper No.
08-3, available at [http://www.bos.frb.org/economic/ppdp/2008/ppdp0803.htm].
19 A fact sheet for the FHA Secure program can be found at [http://portal.hud.gov/portal/
page?_pageid=73,3947211&_dad=portal&_schema=PORTAL].
20 One press report of households trying to adapt to avoid foreclosure is Kareem Fahim and
Ron Nixon, “Behind Newark Foreclosure Data, Ruined Credit and Crushed Hopes,” New
York Times, Mar 28, 2007, p. A1.

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large payment reset additional time to adjust their finances to new market realities.
These families might avoid foreclosure altogether given extra time, which would tend
to reduce the total supply feedback, both during the moratorium period and after its
expiration.
Fence-Sitters, Potential Buyers May Wait for Prices to Bottom Out.
Just as price declines can cause a foreclosure supply feedback process that extends,
rather than shortens, the period of large unsold inventories, price declines may also
have a negative demand feedback effect by deterring potential buyers from entering
the market. Buyers who believe that prices will continue to fall may decide to wait
until the market bottoms out, yet by waiting as a group they have the cumulative
effect of encouraging the price decline.21 That is, expectations of a future price
decline reduce the number of potential buyers at the current price (and all other
prices), which has the effect of putting downward pressure on prices.
The effect of a moratorium on fence-sitters would depend on their expectations,
which may be difficult to anticipate. If fence-sitters believe that a moratorium will
be effective in stabilizing the housing market (perhaps there will be income growth
for families, or wide scale refinances, or rapid inflation during the moratorium
period), then fence sitters would gain little by waiting. On the other hand, if fence-
sitters believe that a moratorium will merely delay inevitable distress sales then the
moratorium could have the perverse effect of further discouraging fence-sitters from
entering the market.
Financial Problems of Banks and GSEs Reduce Demand for
Houses. The mortgage finance system is another factor that could tend to limit the
ability of housing markets to restore equilibrium quickly. In the United States, the
vast majority of home sales require mortgage financing so the supply of mortgage
funds is a critical component of the demand for houses. Falling house prices create
a negative feedback loop in the mortgage finance system because mortgage funds
tend to dry up as housing markets decline. First, when housing prices are declining,
lenders tighten lending standards and require larger downpayments to reduce the
probability of negative equity and default because the decline in the value of the
collateral (the house) increases the risk to the lender in the event of default. Second,
the higher delinquency rate on existing loans that usually occurs concurrently with
falling house prices also reduces the revenues of banks and other mortgage lenders.
Because financial institutions that provide mortgage financing are typically leveraged
(they have liabilities that are many times their capital), the failure of existing
borrowers to repay their loans can force the lenders to curtail new lending by a
multiple of the lost revenue. As a result, the ability of potential house buyers to
obtain financing can be reduced when prices fall, which can further reduce prices.
In the current housing market downturn, the financial condition of many mortgage
21 Reportedly, home builders believe there are a number of potential first time home buyers
who are waiting for house prices to reach their bottom. See Rex Nutting, “Single-family
home starts drop to 17-year low,” Marketwatch, July 17, 2008, available at
[http://www.marketwatch.com/news/story/single-family-home-starts-drop-17-
year/story.aspx?guid=%7BB9547567-8849-4400-9F8F-9A5761A0D99F%7D].

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lenders and related financial institutions, such as Fannie Mae and Freddie Mac, is
significantly troubled.22
A moratorium on foreclosures is unlikely to help mortgage lenders, except those
that might wish to modify loans on a wide scale but are uncertain whether and under
what terms they may legally do so.23 For those lenders and loan servicers with
unencumbered ownership of their loans, they already have the option of delaying
foreclosure proceedings. One reason for not delaying foreclosure is that the declining
housing market is already eroding their capital position and the inability to recover
any funds from a loan exacerbates their problems.24
It is difficult to assess the effect of a moratorium on the factors that tend to
frustrate stabilization in the housing market. In some cases, such as the reaction of
fence-sitters and financial institutions, it depends on expectations and calculations
that policymakers may not be able to anticipate. The primary economic benefit of a
moratorium, in terms of facilitating a return to equilibrium in the housing market, is
that it gives market participants time to evaluate relevant information, such as the
existence of new programs and the completion of new appraisals, after which
existing borrowers and lenders may reconsider their options and negotiating
positions. The next section focuses on the uncertainty in the current housing market.
Uncertainty Affecting Housing Market Participants
Uncertainty is one of the factors contributing to continued instability in
mortgage markets and the financial system. It is difficult in the present
circumstances to know if loan servicers have the capacity to conduct effective loss
mitigation, including alternatives to foreclosure, in the face of rapidly rising
delinquency rates and falling house prices. Press releases by the HOPE Now
Alliance, a coalition of loan servicers and counselors, list hundreds of thousands of
loan workouts but it is difficult to know if these are actions merely begun or actions
completed.25
22 See CRS Report RL34661, Fannie Mae’s and Freddie Mac’s Financial Problems:
Frequently Asked Questions, by N. Eric Weiss. The Treasury and the Federal Housing
Finance Agency placed the GSEs in conservatorship on September 5, 2008.
23 See CRS Report RL34372, The HOPE NOW Alliance/American Securitization Forum
(ASF) Plan to Freeze Certain Mortgage Interest Rates, by David H. Carpenter and Edward
Vincent Murphy.
24 Despite having greater than minimum capital, banks and thrifts are having to set aside
increasingly large loan loss reserves. “Testimony of John Reich, Director of the Office of
Thrift Supervision, before The Senate Committee on Banking, Housing, and Urban Affairs,”
June 5, 2008, p. 3, available at [http://files.ots.treas.gov/87166.pdf].
25 Prior to the December 2007 HOPE Now mortgage freeze plan, the Conference of State
Bank Supervisors (CSBS) did an analysis of HOPE Now data and found that HOPE Now
had not distinguished between loss mitigation begun and loss mitigation completed. Only
a small percentage of the borrowers listed by HOPE Now had completed a new workout
plan. See State Foreclosure Prevention Working Group, April 2008, at
[http://www.csbs.org/Content/NavigationMenu/Home/StateForeclosureApril2008.pdf].

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Loan Servicers. Uncertainty about the value of houses in declining markets,
for example, complicates the ability of loan servicers to evaluate the returns to loan
modification compared with completing the foreclosure process. Similarly,
uncertainty about home values also complicates the funding of new loans that could
serve to bring buyers back into the marketplace because lenders generally raise
qualification standards and down payment requirements if they believe house prices
might fall after the loan is finalized.26
In addition to uncertainty about the value of homes, loan servicers had a period
of uncertainty with regard to the extent of their discretion to modify loans in
anticipation of payment problems. Innovations in financial services had allowed for
a fracturing of ownership of the loans with the result that there was not a single
lender to authorize changes in loss mitigation strategies. This may have resulted in
over-reliance on loan-by-loan loss mitigation efforts instead of greater use of broad-
based action for loan categories experiencing delinquencies on a large scale. Over
the past year, some of this uncertainty has been reduced by a series of industry
standards, Securities and Exchange Commission (SEC) announcements, and Internal
Revenue Service (IRS) rulings.27 Given these recent developments, it is difficult to
establish the accuracy of statements by HOPE Now that loan modifications are
proceeding at an increased pace.
Borrowers. Borrowers must acquire information about their alternatives.
Although there have been outreach efforts, many borrowers might not respond to
loan servicers even when the servicers may be willing to renegotiate more lenient
terms. Similarly, many borrowers may not be aware of the existence of the new
voluntary FHA refinance program or if their lenders might be willing to participate.
Even if they know of the existence of the program, they may not know if they qualify,
or under what terms. For example, the new program requires the new loan balance
to be reduced to 90% of the current appraised value, but no one can know the current
appraised value without conducting a new appraisal. Without knowing this new
balance, troubled borrowers may not be able to accurately assess their own ability to
meet the new monthly payments and so may not know if they themselves would be
willing to participate in the new program.
Lenders. Just as borrowers require information to assess their alternatives,
lenders might require information to assess their alternatives. Before deciding to
participate in the new FHA program, lenders also need information on current house
prices, as determined by a host of new appraisals. The shelf-life of an estimate of an
area’s house prices might not be very long in areas with rapidly declining prices;
therefore, it may be difficult, at least on a large scale, to get information on current
house prices to determine new balances under the voluntary FHA program.
26 Supervisory Insights, FDIC, Summer 2008. Banks are reminded to tighten lending
standards in declining markets for commercial real estate sector. Similar principles apply
to the residential sector. Available at [http://www.fdic.gov/regulations/examinations/
supervisory/insights/sisum08/sisum08.pdf].
27 See CRS Report RL34372, The HOPE NOW Alliance/American Securitization Forum
(ASF) Plan to Freeze Certain Mortgage Interest Rates, by David H. Carpenter and Edward
Vincent Murphy.

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Depending on their assessment of house prices, banks may wish to pursue their own
broad-based alternatives, such as the one put forward by the Federal Deposit
Insurance Corporation (FDIC), rather than participate in the new FHA program, even
if the banks decide to forgo the foreclosure process.28 Similarly, the willingness of
banks to lend to new customers in an area depends on the bank’s changing perception
of the area.
Foreclosure Moratoriums in Historical Perspective
Although inflation-adjusted house prices have occasionally fallen in the past 30
years, nominal house prices have not fallen on a national scale since before OFHEO
began collecting house price data in the late 1970s (falling house prices on a national
scale was more common prior to World War II). In part because inflation generally
adds to the home equity of borrowers with traditional 30-year fixed rate mortgages
and holds down foreclosure rates, it has been several generations since there has been
a call for a mortgage moratorium on a national scale. There have been localized
programs for natural disasters (the aftermath of Hurricanes Katrina and Rita is an
example) in recent years, and there were national efforts prior to World War II. The
following section discusses historical examples of mortgage moratoriums.
Great Depression. The Great Depression saw falling asset prices along with
growing, and persistent, unsold inventories for many commodities and for farm
mortgages. The magnitude of the problem during the Great Depression was far
greater than problems in the current housing market but some of the same basic
economic principles of housing markets, mortgage defaults, unsold inventories, and
financial turmoil might still apply. Prior to becoming chairman of the Federal
Reserve, Ben Bernanke was a recognized expert on the economic connection between
mortgage defaults and broader credit market turmoil during the Great Depression.
Evidence of the effect of state mortgage moratoriums during the period is found in
the work of economist Lee Alston. The following sections describe, for the Great
Depression, the supposed feedback loop between mortgage defaults and financial
market turmoil, reported efforts of market participants to address unsold inventories,
and economic analysis of the mortgage moratoriums during the period.
Mortgage Defaults and Financial Turmoil Feedback in the 1930s. In drawing
lessons from the Great Depression, Bernanke says that a “...major aspect of the
financial crisis (one that is currently neglected by historians) was the pervasiveness
of debtor insolvency. Given that debt contracts were written in nominal terms, the
protracted fall in prices and money greatly increased debt burdens.”29 Bernanke goes
on to explain how debtor insolvency also caused problems for lenders, contributed
to a banking crisis, and ultimately damaged the ability of financial markets to provide
credit intermediation. In Bernanke’s analysis, when a wave of insolvencies causes
a big shock to the lending system, the cost of credit intermediation (the ability to
28 The FDIC instituted its own wide scale loan modification plan for the borrowers it deals
with when it took over IndyMac Bank. Details of the FDIC plan can be found at
[http://www.fdic.gov/consumers/loans/modification/indymac.html].
29 Ben Bernanke, “Nonmonetary Effects of the Financial Crisis,” American Economic
Review, vol. 73 (June 1983).

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distinguish “good” borrowers from “bad” borrowers)30 rises and provides a separate,
nonmonetary channel, through which problems in the banking sector can negatively
affect the real economy. Bernanke cites Depression-era sources who say “...that the
extraordinary rate of default on residential mortgages forced banks and life insurance
companies to practically stop making mortgage loans, except for renewals.”31
Bernanke concludes that economic institutions matter — that “institutions which
evolve and perform well in normal times may become counterproductive during
periods when exogenous shocks or policy mistakes drive the economy off course.”
Some might consider the modern day rise and fall of the securitization of
mortgages as another example of a shock to credit intermediation.32 For example,
Laura Kodres, division chief in the International Monetary Fund’s Monetary and
Capital Markets Department, is one of many critics of the “originate to distribute”
model of mortgage finance. She attributes some of the lax underwriting during the
boom to “Supervisors had insufficient information and clout to halt the proliferation
of overpriced securities. Thus, competitive pressures to issue and sell these types of
products were so intense that — as Charles Prince, Chairman and Chief Executive
Officer of Citigroup, told a reporter in early July that year — top management felt
that ‘as long as the music is playing, you’ve got to get up and dance.’”33 The
securitization system, which appeared to work well during the housing boom, appears
to have become counterproductive since housing markets have declined. Global
collateralized debt obligation (CDO) issuance was 62% lower in the second half of
2007 than in the second half of 2006.34 This decline in securitization occurred
despite the Federal Reserve lowering the Fed Funds rate 25 basis points between
August 2006 and August 2007.35 Even borrowers with good credit are reporting
problems in obtaining loans.
Efforts to Stabilize Markets by Preventing Price Declines. During the Great
Depression, some believed that the way to recovery was to hold products off the
market to slow down price declines, with some actions that in hindsight might seem
perverse — farmers stopping their neighbors’ milk wagons and dumping out the
30 In this context, “good” and “bad” refer to the likelihood that borrowers will repay the
loan.
31 Bernanke citing Hart, Debts and Recovery, 1929-1937, New York, Twentieth Century
Fund, 1938, p. 163. Renewals were similar to a refinance. Many mortgages prior to WWII
were for short periods, often five years or less, with a large balloon payment at the end. As
a result, people would have to roll over their mortgage at regular intervals.
32 See CRS Report RS22722, Securitization and Federal Regulation of Mortgages for Safety
and Soundness, by Edward Vincent Murphy.
33 Laura Kodres, “A Crisis of Confidence... and a Lot More,” Finance and Development,
IMF, June 2008, available at [http://www.imf.org/external/pubs/ft/fandd/2008/06/
kodres.htm#author].
34 SIFMA Research Quarterly, February 2008, p. 8, available at [http://www.sifma.org/
research/pdf/RRVol3-2.pdf].
35 Federal reserve historical data, available at [http://www.federalreserve.gov/releases/h15/
data/Monthly/H15_FF_O.txt].

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milk, for example.36 Reducing inventory to support prices was also one of the
justifications for paying farmers to reduce the amount of acreage under cultivation.
Few observers believe that Depression-era price supports were effective in
facilitating recovery of individual markets.37 In the current housing market, there
have been several efforts to reduce the number of properties for sale and support
prices; for example, some state and local governments have programs to acquire
foreclosed properties and the recently passed omnibus housing bill has provisions for
Community Development Block Grant Funds to be used to acquire vacant
properties.38 A moratorium on foreclosures may give state and local governments
more time to remove vacant properties to try to support prices.
Economic Analysis of Depression-Era Mortgage Moratoriums. Between 1932
and 1934, 25 states passed moratoriums on the foreclosure of mortgages. Economists
might argue that interference with a lender’s ability to recover loan collateral will
tend to either reduce the amount of lending or raise interest rates on new loans.
Economist Lee Alston examined the economic effects of the 1930s moratorium
legislation. Alston found that some borrowers gained from the temporary reprieve,
“but that this reprieve was at the expense of private creditors and prospective farmers
who were precluded from securing credit to purchase a farm because of the increased
costs to private creditors.”39 He arrived at this result by examining whether the
quantity of private loans fell, or the interest rates on loans rose, in states that passed
moratoriums relative to states that did not (controlling for other credit market
factors). He found that the quantity of private loans fell and that interest rates rose
under a variety of model specifications.
Criticism of the Depression Analogy. Some would argue that evidence from
Depression-era moratoriums is not necessarily the best analogy. As discussed above,
farm mortgages were often the primary source of family income so that falling
commodity prices simultaneously reduced the value of the farm and the ability to
make mortgage payments, unlike the present situation in which an individual
household’s income is largely divorced from house prices (although aggregate
regional income may affect regional house prices). Similarly, Depression era efforts
to support prices by reducing supply were largely directed at commodity prices, not
36 For one personal story of the Farm Holiday movement, see the interview of Harry Terrell
in Studs Terkel, Hard Times: An Oral History of the Great Depression, Pantheon Books,
New York, 1970, pp. 213-217. For a discussion of policies to prevent further price declines,
including the “plow up the pigs” campaigns, see Depression Decade: From New Era
through New Deal, 1929-1941 (New York, Rinehart & Co., 1947), pp. 191-197.
37 Other approaches to market stabilization were tried during the Great Depression, which
may have been more effective. For a discussion of one such program, the Home Owner’s
Loan Corporation, see CRS Report RL34423, Government Interventions in Financial
Markets: Economic and Historic Analysis of Subprime Mortgage Options, by N. Eric Weiss.
38 The Ohio Foreclosure Prevention Task Force, for example, recommended the use of
authority under delinquent tax rules for communities to seize properties and in some cases
demolish vacant houses. Final Report, September 10, 2007, p. 23, available at
[http://www.com.state.oh.us/admn/pub/FinalReport.pdf].
39 Lee J. Alston, “Farm Foreclosure Moratorium Legislation: A Lesson from the Past,”
American Economic Review, June, 1984, pp. 445-457.

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house prices. Also, the basic macroeconomic policy approach to recovery, especially
the modern bias toward inflation and expansionary monetary policy as a response to
recessions, may make evidence from prior periods less relevant. Finally, institutions
for financial markets have changed significantly (including greater reliance on global
sources of funding and more alternatives for federal subsidies) since the Depression
so Alston’s evidence may apply to a system that is no longer in place. Finally,
current moratoriums are being considered to give both borrowers and lenders more
time to consider alternatives to foreclosure, not necessarily to stabilize housing
prices; therefore, an example of time pressure may be more appropriate.
Natural Disasters. Sometimes when natural disasters hit, disruptions of
traditional communications can add to the obvious difficulties of distressed residents
to meet their mortgage payments on time. In these situations, it is not uncommon for
there to be a temporary reprieve of debt obligations until normalcy can be restored.
One example of this was a moratorium on foreclosures of FHA-insured mortgages
in the aftermath of Hurricanes Katrina and Rita.40 As in most natural disasters, the
event that caused the communications disruption also reduced the ability of families
to raise funds to pay their mortgages and destroyed some of the housing stock. In the
case of Hurricanes Katrina and Rita, flooding reportedly damaged 1.2 million
housing units. Of those, 300,000 were seriously damaged or destroyed.41 The long-
term impact on some communities was severe and in some cases out-migration may
have permanently reduced the local population.42 These shocks to both the supply
and demand of housing have left an area that arguably remains in disequilibrium.
The moratorium likely provided time for affected residents to determine if they
wished to make a long-term commitment, such as home ownership, to the affected
region.
Some aspects of the natural disaster analogy seem to fit the current housing
market and some do not. If forecasts of the inability of many borrowers to meet
higher payments after initial reset are accurate, then some would argue that the
schedule of resetting mortgages represents an “approaching tsunami of mortgage
40 HUD repeatedly extended forbearance and a moratorium on FHA insured mortgage
foreclosures in the Hurricane affected region. See for example, Mortgagee Letter 2006-05,
February 3, 2006, available at [http://www.hud.gov/offices/adm/hudclips/letters/mortgagee/
files/06-05ML.doc].
41 See CRS Report RL34087, FEMA Disaster Housing and Hurricane Katrina: Overview,
Analysis, and Congressional Issues, by Francis X. McCarthy and CRS Report RL33173,
Hurricane Katrina: Questions Regarding the Section 8 Housing Voucher Program, by
Maggie McCarty.
42 Louisiana’s Road Home Program, for example, had difficulty complying with federal law
because it proposed to adjust aid based on the ability to own in three years, with an
exemption for elderly people planning to leave the state. Some of the other assistance funds,
including federal Community Development Block Grant Funds, were used to turn some
former housing units into green space. See “Testimony of Gil Jamieson,” Deputy Director
of Gulf Coast Recovery, Federal Emergency Management Administration, before the House
Financial Services Committee, February 22, 2007, p. 6.

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defaults.”43 In this view, traditional avenues of communication between borrowers
and servicers are inadequate to handle the volume of renegotiations necessary to
modify loans prior to severe delinquency (most loans that become more than 90 days
late never again become current). In part because of the time constraint, the FDIC
has recommended simply writing down loan balances en masse to more affordable
payments to keep current borrowers in their homes and prevent more housing units
to be added to unsold inventory through the foreclosure process.44
On the other hand, the natural disaster analogy may not be appropriate. Unlike
a natural disaster, neither the housing stock nor the communications network have
been damaged beyond the control of market participants. Rather, borrowers in some
cases avoid communications with loan servicers who try to contact them. Similarly,
some loan servicers might try to contact borrowers but then avoid negotiating more
lenient terms both because it might make it more likely that other borrowers will seek
more lenient terms (borrowers who do not necessarily have an affordability problem)
and because a reputation for lowering balances may be bad for bidding for future loan
servicing contracts. Unlike in a natural disaster, it could be argued that borrowers
and lenders are in a position to bargain.
Other Examples. The Great Depression and Hurricanes Katrina and Rita are
arguably the two extremes — an extreme macroeconomic collapse on the one hand
and extreme natural disasters on the other. The historical record of moratoriums on
debt collections is extensive. For example, the May 1933 edition of the Harvard Law
Review contains a comparative study of moratorium legislation.45 Historic examples
include a court case of Demosthenes regarding a general prohibition on debt
collection actions against Greek soldiers away at war, a general moratorium decreed
by the Emperor Justinian when the Franks invaded Italy and Sicily, and many other
moratoriums during wars. Providing a moratorium on debt recovery has not been
confined to periods of war; many U.S. states attempted to provide moratoriums
during times of economic stress in the 1800s. Excluding war years, the article lists
20 instances in which states tried to impose moratoriums on debt collections. Many
of these attempts by states were found to be unconstitutional, but such restrictions
would not necessarily apply to the federal government.
43 Concern over the capacity of servicers to meet loan modification efforts has been a subject
of ongoing congressional concern. For example, the House Financial Services Committee
held a hearing on July 25, 2008, entitled “A Review of Mortgage Servicing Practices and
Foreclosure Mitigation.” The tsunami analogy has made its way into media coverage, for
example, Christopher Hayes, “The Coming Foreclosure Tsunami,” The Nation, November
13, 2007.
44 The FDIC implemented its own variation on this plan when it took over IndyMac Bank.
The FDIC is trying to contact IndyMac’s delinquent borrowers to offer to write down their
loans to a 38% debt-to-income level. Information on the FDIC plan is available at
[http://www.fdic.gov/news/news/press/2008/pr08067.html].
45 See A.H. Feller, “Moratory Legislation: A Comparative Study,” 46:7 Harvard Law
Review, May 1933, pp. 1061-1085.