Chart of the Day: Foreclosure Contagion

How badly does a foreclosed home hurt its neighbors?

The Center for Responsible Lending says this effect is quite sizable and that all told, 41 million properties across the country are vulnerable to the foreclosure contagion. The resulting devaluation would be in the $200 billion range.

For this reason, Congress has been trying to pass a bill that would stem the tide of foreclosures, expected to be somewhere in the one to two million range. It doesn't make sense that households who can afford their mortgage payments -- or already fully owns their homes -- should be punished for their neighbor's misfortune or bad money management. After all, the home buying process doesn't include credit checks on neighbors.

But using repeat sales and foreclosure data from 1989 to 2007 for 140 communities nationwide, John Harding of the Univ. of Connecticut and Eric Rosenblatt and Vincent Yao of Fannie Mae argue that the 41 million figure is overstated. The reason is that distance counts, and the further away a "good standing" home resides from a foreclosed one, the less the "good standing" home's value will depreciate.

The following chart from the paper shows this effect. Each colored line represents the distance between a foreclosed home and non-foreclosed one: pink is less than 300 feet, red is between 300 and 500 feet, blue is between 500 and 1000 feet, and purple is between 1000 and 2000 feet. (Click for larger)

So, if five homes within 300 feet of a "good standing" home are foreclosed on, then the "good standing" home will see a seven percent hit to its value. Between 300 and 500 feet, the negative hit is a little over five percent. Between 1000 and 2000 feet, the effect is closer to two percent.

The Center for Responsible relied on this study which found that homes within 1/8 of a mile will see their value decline by 0.9 percent when a nearby home forecloses. The big difference between the two studies is that the one used by the Center wasn't able to control for local housing market trends. The Harding, Rosenblatt, and Yao paper does and finds that within 1/8 of a mile, the depreciation is closer to 0.6 percent.

From a policy perspective, our results confirm the existence of a significant negative externality associated with foreclosed properties. However, our estimates of that externality controlling for the local trend in house prices are generally smaller than previous estimates and we provide evidence that the most significant externalities are attributable to immediate neighbors. As a result, a million additional foreclosures would significantly affect fewer than the forty million homes previously estimated.

The researchers also find that the negative hit from a foreclosure is strongest right before a lender takes control of the property. They argue "that when foreclosure is inevitable, efforts to speed the foreclosure process would be effective at reducing the contagion effect."

The current version of the billion housing bill doesn't have any provisions that deal with this problem, but the one part that comes close -- a provision giving $3.9 billion to communities to buy up distressed properties -- could derail the whole bill. The Philly Daily News put it best (emphasis mine):

President Bush had threatened to veto a $300- billion foreclosure-aid bill because $3.9 billion had been set aside for buying and rehabilitating foreclosed properties. Then when Fannie and Freddie faced a crisis, the irony-challenged administration asked for a blank check to back them up.

UPDATE
And the veto threat is no more.