A Better Way to Fix the Foreclosure Process

Edward L. Glaeser is an economics professor at Harvard.

In the 1990s, capitalism was on the march and the United States mortgage market seemed like a model. In much of the world, it seemed miraculous that ordinary Americans could move into a big home by borrowing large sums of money for 30 years. A crucial element in the American system was that lenders could take the homes of delinquent borrowers; it was impossible to imagine a well-functioning mortgage market in places like Russia and Bolivia, without a similar ability to foreclose.

Today, the great mortgage morass has elicited constant calls for a publicly enforced foreclosure moratorium. But shutting down the foreclosure process would only delay the inevitable and take yet another step away from the rule of law. A far better solution would be to experiment with ways of providing more legal resources to borrowers and courts that would make the foreclosure system more efficient and fair.

Any foreclosure invites outrage. Our empathy naturally goes out to a family forced from its home, so any excuse, like sloppy paperwork on the part of a bank, can seem like a reasonable justification for stopping a foreclosure. But such emotion is rarely a good basis for economic policy.

No foreclosures would ultimately mean no private mortgages, because the ability to collect collateral is crucial for lending. Without foreclosures, public mortgage insurance would become even more of a drain on taxpayers. As it is, the government should reduce the artificial subsidies of home borrowing and homeownership through the home mortgage interest deduction on the federal income tax.

But the public sector should continue to provide the legal infrastructure needed for private lending. Borrowers must be able to write binding contracts where they promise to leave their home if they fail to make payments. While we must accept the necessity of foreclosure, we should not tolerate foreclosure on borrowers who aren’t delinquent or where the lender lacks a clear right to foreclose.

Today, the system appears to be allowing too many cases where the legality is foggy at best. Last week, all 50 state attorneys general announced they would investigate foreclosure practices.

In the long run, we need sensible legal changes to make foreclosures more fair and more efficient. But that will take years, and we need help now, which means the system needs more legal aid for courts and the less fortunate. We can improve the situation without changing the rules or shutting down foreclosures altogether by providing more, not less, rule of law.

While banks can be counted on to look after their own legal interests, homeowners often lack the resources to prepare their own cases effectively. As The New York Times reported on Friday, the home of a woman in Maine has been saved, so far, from foreclosure because of the philanthropic support of a retired lawyer. Every criminal defendant has access to a public defender, but not every poor homeowner can afford a foreclosure expert, despite the best efforts of many legal aid groups.

In some cases, overwhelmed courts also lack the resources to investigate every foreclosure properly. So let’s increase the legal resources available to borrowers and courts.

There are many possible ways to do this. One would be to encourage more private philanthropy with a tailored tax credit for qualified lawyers. For example, if a lawyer provides a reasonable number of hours of free aid to a distressed homeowner, that lawyer could receive a reasonable tax credit. Many lawyers already do pro bono work, and a generous tax credit would spur more aid.

A larger and more expensive approach would be to provide a voucher of up to $2,000 of legal work to lower-income distressed homeowners. Anyone who faces foreclosure and is either unemployed, or earned less than some threshold last year, would be eligible for the voucher.

Some courts seem to need help as much as individual homeowners do, and the federal government could help, despite the state-by-state idiosyncrasies of the foreclosure process. The government could create a temporary office, probably housed in the Department of Housing and Urban Development, that would provide legal support for courts in foreclosure cases, either with public lawyers or by paying for private lawyers. The office — at the request of a judge — could provide a fixed amount of legal support for each case.

Any proposal will raise issues, which is why it makes sense to experiment and see what happens. Ideally, any solution would be temporary and could be re-examined after a year.

Providing more legal support comes at a cost. If two million cases involved a $2,000 voucher, the cost would be $4 billion. But that is far less than the costs of other programs aimed at reducing foreclosures. Ideally, these legal services would be paid for with foreclosure fees that originators pay if their loans end in the courts.

The mortgage market needs greater rule of law, not less. A foreclosure moratorium moves us in the direction of greater uncertainty and legal chaos. I don’t like the idea of paying greater legal fees anymore than anyone else, but there are times when we need to improve our legal infrastructure, and that means more lawyers’ hours.