New research from economists at the Federal Reserve Bank of Boston is raising questions about whether foreclosures are really as damaging to nearby property values as people think – and whether laws in place to prevent them are doing more harm than good.

The researchers found that the knock-on effects of foreclosures were small, shaving perhaps 1 or 2 percent off the sale price of nearby properties.

“There is this belief out there that the effect is big. But the effect is surprisingly small,” said Paul Willen, a senior economist and policy advisor at the Federal Reserve Bank of Boston. “The effect is there – it’s statistically significant – but it’s not necessarily economically significant, something a buyer would notice.”

But more importantly, the research also suggests that the decline in neighborhood prices doesn’t begin when a property is finally foreclosed on, but rather when the property first becomes delinquent, often many months, even years, before the foreclosure itself.

Long Timelines

The paper, written by Willen, fellow Fed economist Kristopher S. Gerardi and Fannie Mae staffers Eric Rosenblatt and Vincent W. Yao, examined the effect of foreclosures on nearby home sales nationwide. One reason the paper came to different conclusions than prior investigations is that the researchers didn’t simply compare prices among all houses in a given radius of the foreclosed home, but separately examined those within a neighborhood, using census block data.

“It’s about making sure that when we’re comparing two properties that we’re comparing properties which are very close to being the same. If you have two properties that are [far apart] and one’s at a different price than the other, we can’t tell if that difference is because of a nearby foreclosure or because one’s in a different neighborhood than the other,” Willen said. “We’re trying to get down to a level where the only possible reason for the difference in price is because of the foreclosure.”

And if the Fed’s data is correct, it suggests that a lot of the public policies aimed at fixing the foreclosure crisis are wrong-headed.

“A lot of the laws, a lot of the rules that we’ve come up with to deal with this foreclosure crisis, have extended the period in which the borrower is delinquent, and stretched out the foreclosure timeline,” Willen said. “Some people thought that might be good, because it was preventing the properties from coming on the market. This shows that’s bad, because it’s just delaying the point where the property gets into the hands of a new owner and stops being a drain on the community.”

Only Fair?

In Massachusetts, the amount of time a borrower has to prevent a foreclosure from occurring – that is, to “cure” the delinquency and get the loan current – has twice been extended, from 30 days before the foreclosure crisis to 90 days in 2008 and 150 days in 2010. Technically, lenders can still foreclose in 90 days if they meet with the borrower and make a “good faith effort” to come up with an alternative to foreclosure. But lenders have been reluctant to take advantage of this provision in the law for fear of incurring additional legal liabilities.

Proponents of the law argue that giving borrowers as much chance as possible to hang on to their homes is only fair. In addition, they say that the real damage to neighborhoods occurs not simply when owners

get behind, but when properties become vacant, which can occur many months before the foreclosure itself is completed, and may account for the decline in value shown in the Fed report. By extending the time people have to meet with their lenders and try to come to an agreement, it helps prevent the very damaging abandonment phase.  

“The question is whether they’re still living in the house while that process is taking place,” said Barry Bluestone, a professor of economics at Northeastern University and director of the Dukakis Center for Urban and Regional Policy. “What you want to do is keep them in the home and work with them while they’re in the home, because once they’re out of the home there’s very little chance of getting them back in there.”

No Incentive

“I agree at least in theory that trying to put the properties back into productive use is important, as we all know. But I also think trying to keep individuals in their home is important too,” said Brenda Clement, executive director of the Citizens Housing and Planning Association, which lobbied to extend the right-to-cure period. “I think we need to have multiple tools to address these situations, because property owners are at different stages and have different problems.”

Bluestone points to his own hometown of Detroit as an example of why it’s worthwhile to keep people around. He recently visited his childhood home, and said that “if you look from one side of the street, it looks like a great place to live. From the other side, [where there are several boarded-up homes] it looks like a war zone. So I’m not surprised that property values in Detroit, even among these gorgeous homes that would sell for $800,000 in Brookline, are selling for $30,000 … it’s not just that two foreclosures is worse than one, but three foreclosures is six times as powerful. And if half the houses are abandoned, the value plummets.”

Willen said he disagrees.

“If a borrower knows the house is going to end up in foreclosure, the borrower really has no incentive to keep up the property,” he said, and therefore it’s better to get it into new hands as quickly as possible.