A decade after the mortgage crisis swept California, home prices are rising, far fewer borrowers are under water, and the state’s economy and government’s finances are strong. Two little-discussed anti-foreclosure laws deserve much credit for slowing the initial devastation and for helping to stabilize the housing market and the economy.
The rapid response of Sacramento lawmakers to the mortgage crisis merits national consideration, too. The state’s policy was more effective than federal housing-relief programs enacted nationally.
California foreclosure prevention laws reduced foreclosures by 16 percent, keeping an additional 124,000 foreclosures from occurring, and preserving some $310 billion in state-wide housing wealth.
The federal response merely created the possibility for distressed homeowners to apply for relief, without imposing ample incentive – or regulation – to induce lenders to make deals with homeowners. California’s approach put the burden on lenders, with new rules that made it harder to start the foreclosure process in the first place, and financial penalties for not maintaining foreclosed properties.
The enactment of California foreclosure protection laws in mid-2008 and early 2009 had an immediate impact. The state’s level of mortgage distress, which had been rising in line with the national rate, dropped below the national pace once the laws kicked in. Mortgage distress in California remained well below the national rate through the crisis period and beyond.
Research that we conducted with Matteo Iacoviello of the Federal Reserve Board estimates that the California foreclosure prevention laws reduced foreclosures by 16 percent, keeping an additional 124,000 foreclosures from occurring.
Our analysis incorporated housing data from federal agencies, the Mortgage Bankers Association, and real-estate data site Zillow. Our most conservative estimate is that slowing the foreclosure pipeline in the depths of the crisis buoyed prices 6.2 percent from where they would have otherwise landed.
We estimate that translated to preserving $310 billion in state-wide housing wealth. A more granular analysis that relied on ZIP-code level information shows a 9.2 percent median relative price gain thanks to the imposition of the foreclosure prevention laws – the equivalent of $470 billion in California housing wealth preserved.
Without minimizing the devastation that occurred for many California households, the crisis could have been far worse.
ZIP-code level data shows the state’s foreclosure prevention laws served as a lifesaver for the majority of homeowners living along the I-99 corridor.
Indeed, California’s policy response in the heat of the crisis was faster to market and more effective than the federal Home Affordable Modification Program (HAMP) and Home Affordable Refinance Program (HARP). Those federal programs became law in 2009, but weren’t up and running until 2010, nearly two years after California’s first state foreclosure prevention law hit the market. Nor were they designed for maximum impact.
It was the federal government’s position that temporary moratoria on foreclosure would likely only delay, not prevent, ultimate large-scale home foreclosures. Weak carrots given to lenders in the midst of a crisis were clearly not enough to provide broad or timely help for homeowners battling plummeting home values and rising unemployment.
Moreover, the federal programs required borrowers to fend for themselves. Borrowers had to apply for relief, submitting financial records – and often resubmitting multiple times over weeks and months – only to have their applications get stuck in an understaffed review pipeline.
California took a decidedly different approach.
Rather than leave it to borrowers to try to negotiate for themselves, Sacramento made it harder and more expensive for lenders to initiate foreclosure. Some states require foreclosures to wend their way through the courts; California does not require this braking mechanism on the process. Thus, having Sacramento step in to slow the tide with legislation had the potential to be especially effective.
Rather than leave it to borrowers to try to negotiate for themselves, Sacramento made it harder and more expensive for lenders to initiate foreclosure.
The first of the California foreclosure protection laws, passed in July 2008 and effective through 2012, required a lender to make a more concerted effort to alert distressed homeowners that it was considering proceeding with foreclosure, and that the borrower could schedule an appointment to discuss modification options.
Senate Bill 1137 required lenders to make a good faith effort to contact homeowners in person, or via a phone call, rather than the old system that only required a letter be mailed announcing the intent to foreclose. The new law also required the lender to wait 30 days after making initial contact with a borrower to send a “notice of default” letter that signaled the formal start of the foreclosure process. The law also brandished a potent financial stick: Lenders could be fined up to $1,000 a day for any foreclosed property they did not properly maintain.
We estimate that these changes prevented 10,000 home foreclosures in just the first three months SB 1137 was in effect.
Another foreclosure prevention law, passed in February 2009, slowed the foreclosure process even further. Lenders who did not offer loan modification options to distressed borrowers were required to wait six months after sending a notice of default to foreclose, doubling the three-month wait that had been standard California policy before the crisis.
The anti-foreclosure laws also nudged lenders to consider modifications more than they might otherwise. Our analysis suggests that the rate of California loan modifications rose 27 percent after the foreclosure prevention laws took hold.
It wasn’t only homeowners who weren’t foreclosed on who benefited. Removing potential foreclosures from the market helped preserve values for nearby homes; anyone who watched a foreclosure fire sale reduce the “comp” value of neighboring homes needs no further explanation on that front.
Also, the foreclosure prevention laws helped to preserve bank solvency by reducing large scale take-back of property during a period of plummeting property values.
We also looked at whether California’s anti-foreclosure laws helped the broader economy recover faster. Prior research has found a strong relationship between housing wealth and car sales. As housing wealth improves, consumers are more inclined to buy cars and other durable goods.
We created a model that compared auto sales in California during the period when the anti-foreclosure laws were in effect, to car sales in other states that have a similar foreclosure process, but did not enact laws like California’s. We estimate that the stabilizing effect the foreclosure prevention laws had on home prices pushed California car sales nearly 15 percent higher than they would have been without the foreclosure intervention.
One job of policymakers is to plan and anticipate, and California’s foreclosure prevention laws worked as intended.
While the success of California’s foreclosure laws is evident today, there was concern during the crisis that the big hand of government would ultimately cause business to recoil, making it harder for new borrowers to get a mortgage. We find no evidence of this.
Mortgage denial rates in California were no higher than in other states hard-hit by the housing bust (Arizona, Florida and Nevada) that did not step in with robust foreclosure-mitigation programs. Nor did the anti-foreclosure laws lower the volume or dollar value of loans compared to other hard-hit states.
As the continued rebound in the housing market attests, the impact of California’s foreclosure intervention a decade ago was lasting. And it didn’t pack unintended consequences in the long term.
No one wants to revisit the mortgage crisis, but one job of policymakers is to plan and anticipate. California’s foreclosure prevention laws worked as intended, and other state legislatures and federal lawmakers should consider them a worthy template.
Stuart A. Gabriel is the Arden Realty Chair professor of finance and director, Richard S. Ziman Center for Real Estate at UCLA. Chandler Lutz is an associate professor in the economics department at Copenhagen Business School.