As Congress returns from its August recess, lawmakers face a continuing foreclosure crisis and urgent need to enact policies that stabilize the mortgage market and keep more Americans in their homes.

 

Researchers at the University of North Carolina Center for Community Capital say that effective response starts with understanding the real culprits and causes that led to the housing crisis.

 

In a new essay, "Exposing the Myth of Irrational Exuberance: What Really Led to the Housing Crisis,” UNC Center for Community Capital Director Roberto Quercia rejects claims that “boom psychology” led to the global financial meltdown. Instead, Quercia says, the root cause was very real: market participants acting in a rational manner in response to short-term economic incentives.

 

Why is this important? If the key causes of the crisis were “irrational” and “psychological,” there is little to be done except hope for more sober behavior next time, Quercia says. However, if the key cause was economic incentive and the market's inability to police itself, then the responsibility rests with regulators and a restructuring of incentives.

 

Two recent center studies suggest specific actions policymakers and mortgage servicers can take to begin reducing foreclosures and redefaults to help stabilize housing markets.

 

Reducing mortgage balance on “underwater” properties can save more homes. In “Tailoring Loan Modifications: When is Principal Reduction Desirable?” center researchers analyzed more than 51,000 loan modifications nationwide. The data show that the current government plan, which aims to prevent avoidable foreclosures, should help many troubled borrowers because it contains the key component that our research shows makes home loans more sustainable: mortgage payments are reduced enough to be truly affordable to the borrowers. However, a lack of specific guidelines for reducing loan balances limits the success of the program.

 

It’s an important omission because the current crisis is being exacerbated by the problem of “underwater” homeowners – those who owe more than their home is worth and are more likely to default on their mortgage, particularly because they cannot sell their house if they want to move for employment or to reduce housing costs.

 

Our results show that modifying certain loans by reducing the balance that is owed results in the lowest risk of redefault and provides the best returns for investors in many cases, especially in the states hardest hit by the subprime lending crisis.

 

Default servicing is fatally flawed. A second study, "Mortgage Servicer Response to Borrowers in Crisis: A Report from the Front Line,” reports on focus-group discussions with foreclosure-intervention counselors in 12 states.

 

These interviews reveal how borrowers trying to do the right thing and reach out for help often encounter frustrating and unproductive experiences with their lenders, frequently losing their homes despite their efforts.

 

At the same time, counselors trying to work with servicers to help troubled borrowers report a lack of capacity and systemic inadequacies that present serious obstacles to the successful resolution of delinquent loans.

 

Servicer improvements that counselors say would help are: process efficiencies, better communication, more consistency and offering solutions that actually help homeowners stay in their homes. The administration plan, they find, is making a difference in servicer response. But our research suggests more sweeping changes are needed to staunch the overwhelming flow of foreclosures.

 

 

The housing crisis is not going away. As dismal as it appears, the crisis provides an opportunity for policymakers to examine an outdated and flawed system and make improvements that stabilize and strengthen the industry and housing market for the future.

 

The center recommends:

More information on housing finance, complete study findings and Dr. Quercia’s essay are available at www.ccc.unc.edu.