Cost Benefit Analysis of Debtor Protection Rules in Sub-prime Market Default Situations

BABC 04-22: Debtor protection rules ought to influence debtor/creditor interaction at three points: postdefault pre-foreclosure negotiations, the rate of default, and the cost of credit. Their cumulative impact should be different for “high road” than for “low road” sub-prime creditors. “High road” creditors make money through loan performance, invest in minimizing default, and lose money when they have to foreclose. “Low road” creditors also make money through loan performance, but invest in quick, low cost foreclosure, and anticipate sometimes being able to appropriate some or all of the debtor’s equity. Enforced non-waivable debtor protection would likely significantly increase low road but not high road costs, and shift market share from low to high roaders, possibly putting the low road out of business. This might well be desirable from an efficiency point of view, given the tendency of borrowers to under-insure against default, and from the point of view of distributive equity, as well as avoiding adverse neighborhood effects of current low road practices…