A wave of foreclosures seems to also produce a "disamenity effect": someone who defaults on her mortgage slacks on maintaining the house, and its appearance of disrepair drags down the desirability of the neighborhood.
In some states, the law requires that lenders process foreclosures in state courts. Judicial foreclosure laws result in foreclosures costing much more time and money than they do in states like California, which does not have judicial foreclosure laws. The upside to not having judicial foreclosure laws is efficiency — for both the lenders and the government. The downside is that, following market shocks, foreclosures are in danger of spiraling out of control, as they seemed to be in California in 2008. In the midst of the crisis, hundreds of thousands of people lost their homes to foreclosure, and it emerged that banks were "robo signing" on the procedural documents: They were pushing foreclosures through at an unreasonable rate, often without justification or authority to do so.
In 2008, California state senator Don Perata of Oakland authored SB-1137, the first of the California Foreclosure Prevention Laws. SB-1137, and the 2009 California Foreclosure Prevention Act after it, both increased the time and the monetary cost of foreclosing on property in California.
"The mortgage crisis is taking a terrible toll on Oakland and the rest of California," said Perata, as quoted in the SB-1137 analysis. "It is crucial that we give homeowners the tools they need to avoid foreclosure when possible because that's the best outcome for everybody."
A Missed Opportunity
Gabriel, Lutz and Iacoviello's research suggests these laws saved the state hundreds of billions of dollars. They reached that conclusion by taking data from other states, and using it to determine what California's economic trajectory might have looked like without the CFPLs.
They used two methods that yielded similar results. In the first, they compared California's statistics to states with similar housing markets (Arizona, Nevada). Like California, these states:
Experienced a substantial boom in house prices during the 2000s
Suffered high default rates and plummeting house prices during the housing bust
Are often grouped together in descriptions of the excess that transpired during the 2000s housing boom
As you can see, the rate of foreclosure in California looked a lot like the rate in Arizona and Nevada until the foreclosure prevention laws took effect, when they parted ways dramatically. The other states went on to suffer waves of worsening foreclosures for much longer after California started trending toward normalcy.
The researchers also used the synthetic control method to simulate California without the CFPLs, based on data from other states. The real California had a much lower rate of foreclosure than its simulated model. Researchers estimated the laws prevented 124,000 foreclosures statewide.
Former Treasury Secretary Lawrence Summers, director of the National Economic Council during the crisis, has written against policy "delaying inevitable foreclosures." But when the CFPLs were sunsetted (January 2011 for the California Foreclosure Prevention Act and January 2013 for SB-1137), foreclosure rates in the real California didn't bounce up to compensate. Foreclosures were actually prevented, not temporarily forestalled.
The laws functioned much like a temporary liquidity facility does in a banking crisis, halting a depositor run on banks. In the banking crisis case, the banks are the borrowers, and their clients are the lenders. In a mortgage crisis, homeowners are borrowers, and banks and mortgage institutions are lenders.