TEN MILLION PEOPLE

In the peak years of the foreclosure crisis, from 2007 to 2012, almost one American adult in twenty lost a home because of inability to afford the mortgage payments. That amounts to more than ten million people.

The human face of the foreclosure crisis can be hard to see in numbers like these. The most commonly available foreclosure statistics are collected by the mortgage banking industry for the benefit of investors and count loan transactions or houses—not families or people. Take one such statistic, the foreclosure start rate. This is the percentage of outstanding mortgage loans that entered the foreclosure process within a given period of time. By convention, the foreclosure start rate is measured quarterly. Figure 1 depicts the annual average of the quarterly foreclosure start rate since 1986. It shows that the foreclosure start rate was more or less constant until it began increasing rapidly in 2006. The rate peaked in 2009. (As of 2013 it was still near a record high—meaning that mortgaged homes were still being added to the foreclosure inventory at something very close to the fastest rate ever recorded.) It is easy to forget that every vertical inch on this line graph represents hundreds of thousands of homeowners, each receiving an official notice that a banking institution has initiated legal proceedings to repossess their home.

Every foreclosure is the end of someone's personal story. It begins when someone takes out a mortgage to buy a home. Then they miss a few loan payments. Then the missed payments pile up. After several months of late payments, the mortgage holder, which is typically a lending institution—though not necessarily the same institution that originally made the loan—may initiate the legal paperwork for a foreclosure sale. The precise timetable varies from state to state, but in every state the paperwork includes sending a legal notice to the borrower that foreclosure is imminent. And that legal notice starts a clock ticking.

At this point the stories may diverge. A homeowner who receives a notice of default has a short time and a few options. One is to make good on the late payments, or "cure the default," in the jargon of the industry. If that is impossible, then the homeowner may try to persuade the mortgage holder to renegotiate the terms of the loan. If the mortgage holder is not willing to renegotiate the mortgage, it may still be willing to write off some or all of the remaining debt if the homeowner can sell the property, perhaps for less than the amount of the debt (a "short sale"). If a short sale proves impossible, the homeowner might be able to cancel the debt and avoid the trouble of a legal proceeding by signing the property over to the mortgage holder (a "voluntary conveyance"; the document is sometimes called a "deed in lieu" of foreclosure). If none of these options proves possible before the clock runs out, then the mortgage holder or its legal representative may put the property up for sale. This seizure and sale of the property is the foreclosure proper. If no one bids enough, the mortgage holder may itself buy the property, in hopes of putting it up for sale again at a later date when prices have increased; in the meantime, the property is said to be "real-estate owned." Regardless of who buys the property, once it is signed over or sold the former owner is dispossessed. If he or she is still living in the property, then he or she may be subject to eviction. Most foreclosed homeowners clear out before the sheriff shows up.

In the peak years of the crisis, most homes in default went all the way to foreclosure. Lenders and servicers renegotiated less than a quarter of delinquent home loans, and even some of those eventually ended up as foreclosures. In some circumstances, borrowers were able to sell off the property for less than the cost of the loan or simply turn over the deed and have the bank take most of the loss, but such short sales and voluntary conveyances were also relatively rare until late in the crisis. A very few borrowers were able to cure their delinquencies without help from lenders. As loan interest rates reset, unemployment rose, and home equity diminished, a growing number of families simply couldn't make their payments. Others might have been able to stave off default for a while longer, but decided that it did not make sense to strain their finances only to end up owing more than their houses were worth.

The final chapter in the story of a foreclosure depends on the precise steps taken by the borrower and the lender. It also depends on the precise legal framework. In about half of the states, the path to a foreclosure goes through the courts: the lender must file a lawsuit to initiate a foreclosure, and the sheriff's office conducts an auction. In the other states, a lawsuit is not required; the process begins as soon as the lender notifies the appropriate local officials, and it moves considerably faster. Regardless of these differences, the story generally ends the same way: defeated people pile their belongings into a car or van, drive away, and try to start over.

THE BUBBLE AND THE CRASH

To understand how so many people lost their homes, we have to understand how so many people came to take out loans that they could not pay back. And to understand how that happened, we have to understand why anyone was willing to lend them the money in the first place.

The answer is that for a time, the rules of the mortgage market made it profitable to lend to them. These rules were new. They replaced an old framework that dated from the Great Depression, when the housing market and banking sector were in turmoil and foreclosures were widespread. The federal government responded by refinancing hundreds of thousands of mortgages—and also by standardizing rules of mortgage lending so that the same thing wouldn't happen again. It promoted and insured the longer-term, fixed-rate, fully amortizing loans, the "plain vanilla" loans that Americans eventually came to take for granted. The government also established a publicly regulated secondary mortgage market that provided capital to lenders. Federal regulations limited the ability of investment banks to gamble with mortgages, and together with other regulations like state antiusury laws, these rules stabilized the market and provided some protection for borrowers. The government also set underwriting standards for loaninsurance, which improved affordability and housing quality for many Americans. Not all of the old rules were benign: some of the standards discouraged lending to minority and integrated communities, a practice that was called "redlining" because of notorious mid-twentieth-century maps that depicted such neighborhoods with red lines drawn around them, indicating they were disfavored places to lend. Although loans were not provided equally in all neighborhoods, government policy nevertheless enabled millions of new borrowers to receive access to loans that they could afford, with terms that they could understand, from lending institutions that wanted to see those loans repaid.

Policy-makers began to change the rules...