Moral Hazard in Housing Policy: Takeaways from Judicial State Delinquencies

Abstract

The longer foreclosure process in judicial states gives borrowers an incremental “free rent benefit,” potentially contributing to higher delinquencies compared to non-judicial counterparts. Based on rational expectations, we estimate that borrowers in judicial states perceive about 10–16 extra months in the foreclosure process, compared with non-judicial states. We estimate judicial effects (percentage increase in current-to-delinquent roll rates in judicial states, adjusted for other credit risk factors) to be about 20%. They are generally higher for higher CLTV loans, and also for higher FICO, and other stronger borrowers. For agency high CLTV pools, the concentration of loans from judicial states can be an important driver of delinquency buyout speeds. The judicial effect allows us to quantify the impact of moral hazard. Policy makers designing mortgage modification policies should take this into account, in our view.