The full paper in PDF file

The United States (US) housing crisis is widely believed to have sparked and propelled today's financial and economic meltdown. The objective of this paper is to ascertain whether foreclosures are more favorable to lenders than renegotiating loans in the US, and its implications for Israel. The multitude of foreclosures occurring in the US displays the lack of success of current US government programs to reduce them. We survey the extensive underlying reasons for their shortcomings. An analysis of observational, statistical, and historical data disputes mainstream views that renegotiation is necessarily more profitable than foreclosure for US lenders, and does not support generally held views that weak servicer incentives and junior lien holders are the root causes of the lack of renegotiation. Using that information, we review deeper rationales for the massive amount of foreclosures that are occurring. An analysis of a number of different models leads to three theories based on screening practices, deterrence effect, or asset liquidity, which reframe our understanding of the crisis. All three cases substantiate the conclusion that due to the nature of collateralized loans, especially mortgages, it can be more profitable to foreclose than to renegotiate loans in the US. Applying the analysis outlined in this paper to the Israeli financial system, we find that renegotiation of mortgage and, perhaps, corporate debt is likely to be considerably more appealing to lenders in Israel than lenders in the U.S. The important implication of our analysis is that for US lenders, even during a crisis, foreclosure may actually be the better option.