Mortgage Foreclosures: To help or not to help?

As the subprime crisis deepens in the US, more and more people are finding it difficult to make payments for their home loans (mortgages). As a result, banks are re-possessing their houses to sell them off and recover the loan amount. As many people are being forced out of their houses (foreclosure), there is increasing pressure on the US government to help these people. However, there are some side-effects to this which need to be considered.

Economic cycles are inevitable and booms are followed by bursts and vice-versa. During a burst, demand goes down. Hence prices decrease rapidly. Thus demand picks up again and this sows the seed for future growth. There is always a danger in stopping or slowing down the price decrease - as this can prolong the burst.

The US government has put pressure on banks and lending institutions to help mortgage borrowers avoid foreclosure. When this happens, banks come up with arrangements that help borrowers retain their houses for some more months. However, finally once the arrangement ends, people end up foreclosing anyway.

What the temporary arrangement ends up doing, though, is that it delays the whole process of price reduction. As people stay in houses longer than they should, they reduce supply and price reduction is hampered. For a good recovery to begin, markets have to adjust to natural equilibrium level. The US government’s efforts to keep prices artificially elevated will delay this process, prolonging the pain for the rest of the economy. When a person can buy a house and rent it out and generate a positive cash flow, houses will be reasonably priced. Till then buyers will shy away from buying.

Another side effect is future borrowers are faced with a restricted supply of houses and hence higher prices. On top of that interest rates on loans are sky-high, because banks needed to compensate for the fact that they will not be able to re-posses and sell houses for bad loans. Thus new buyers are penalized.

Given the state of the US economy there is every need to help the people impacted by the crisis. However, the US government needs to weigh the benefit of helping people who took on loans they did not deserve, versus prolonging the crisis and affecting people who had nothing to do with this in the first place.


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This post presents a point of view which differs from conventional wisdom. Apart from being a good read (hopefully), it can also be a good starting point to help readers, preparing for CAT (IIM) or other MBA interviews, think differently. Since the data / facts for these posts are derived from a host of sources and websites, readers are advised to cross-check the authenticity before using them anywhere.