Mortgage Relief Legislation May Produce Winners and Losers: St. Louis Fed Analysis

ST. LOUIS — If the U.S. experience during the Great Depression offers any guidance, imposing a temporary ban on foreclosures in response to the current financial turmoil could create unintended costs, based on an analysis from the Federal Reserve Bank of St. Louis.

David C. Wheelock, an economist with the St. Louis Fed, wrote the analysis for the November/December issue of Review, the Reserve Bank's bi-monthly journal of economic and business issues. The publication is also available online at the St. Louis Fed's web site: https://research.stlouisfed.org/publications/review.

Nearly 1 percent of U.S. home mortgages entered foreclosure during the first quarter of 2008, and almost 2.5 percent of all home mortgages were in foreclosure at the end of the quarter. In contrast, as many as half of urban home mortgages were delinquent on Jan. 1, 1934, the height of the Great Depression.

During the Great Depression, state and local governments responded to the rise in mortgage foreclosures primarily by changing their laws. Several states enacted temporary moratoria on foreclosure, while others made permanent changes that limited the rights or incentives of lenders to foreclose on mortgaged property.

Wheelock's report shows that 27 states adopted foreclosure moratoria during the Great Depression. Moratoria were especially common among states in the Midwest and Great Plains, but were also imposed by several states in the Northeast and Far West.

"Foreclosure moratoria generally applied to both farm and nonfarm residential mortgages," said Wheelock. "However, the pressure for foreclosure moratoria was particularly intense in Midwestern states where farm foreclosure rates were especially high."

He noted that these moratoria and other changes to state mortgage laws enacted during the time favored borrowers over lenders. He also said several states enhanced the rights of borrowers to redeem foreclosed property and limited the rights of lenders to sue for deficiency judgments. Not surprisingly, these changes led to lower farm foreclosure rates—but with a cost.

"Although the economic and societal benefits of lower foreclosure rates are difficult to measure," Wheelock said, "research shows that the foreclosure moratoria of the Great Depression imposed costs on future borrowers."

He cited several studies—some looking at the Great Depression and some considering more recent data—that suggest foreclosure moratoria tend to encourage lenders to reduce the supply of loans and may lead to higher average interest rates for subsequent borrowers.

"The evidence from the use of foreclosure moratoria during the Great Depression demonstrates how legislative actions to reduce foreclosures can impose costs that should be weighed against potential benefits," Wheelock concluded.

With branches in Little Rock, Louisville and Memphis, the Federal Reserve Bank of St. Louis serves the Eighth Federal Reserve District, which includes all of Arkansas, eastern Missouri, southern Indiana, southern Illinois, western Kentucky, western Tennessee and northern Mississippi. The St. Louis Fed is one of 12 regional Reserve banks that, along with the Board of Governors in Washington, D.C., comprise the Federal Reserve System. As the nation's central bank, the Federal Reserve System formulates U.S. monetary policy, regulates state-chartered member banks and bank holding companies, provides payment services to financial institutions and the U.S. government, and promotes community development and financial education.

# # #