Should the federal government and the states seek to halt mortgage foreclosures during hard financial times—and do the costs outweigh the potential benefits? With Congress looking for ways to reform mortgage bankruptcy rules, the experiences of the 1930s can help inform the decisions of the present.
In a recent Fed study titled “Changing the Rules,” Dave Wheelock, an assistant vice president and economist at the St. Louis Fed, examined the mortgage cost/benefit tradeoff when foreclosure moratoria were imposed during the 1930s. Faced with an unprecedented number of farm and residential foreclosures during the Great Depression, many states imposed temporary halts to foreclosures alongside other mortgage relief efforts.
Wheelock looked at the data to see why some states imposed moratoria while others avoided them. In short, while moratoria appear to have reduced the rate of foreclosures, they also appear to have reduced the availability of loans and made credit more expensive. Which side of the equation a state fell on depended on which was seen as more important.
“Over the longer run, foreclosure moratoria and other changes in mortgage laws may have made loans costlier or more difficult to obtain,” Wheelock wrote. “Critics argued that foreclosure moratoria induce lenders to restrict the supply of loans and raise interest rates to compensate for the possibility that their right to foreclose on delinquent loans or to collect deficiency judgments will be constrained.
“(On the other hand) in many states, the societal costs of widespread foreclosures were viewed as exceeding the costs of reduced loan-supply and higher interest rates borne by prospective borrowers,” Wheelock wrote. “Furthermore, foreclosure moratoria generally were viewed as expedients to buy time for the economy to recover and for the federal government to initiate programs to refinance delinquent mortgages.”
Now, with foreclosure rates not seen since the Great Depression, many policymakers are looking toward methods used during that time. Policymakers should therefore look not only to what was done, but the potential costs. “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 wrote.
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