Zombie Houses

ABC News reports that foreclosed and neglected houses are driving down neighborhood house prices.

The reason why the houses are neglected is because until the foreclosure process ends, the bank has no responsibilities to take care of the house, which takes many years.

This is a text book case of production of negative externalities when an agent does not internalize the costs. The bank does not suffer from the debilitating house in the short term, instead the neighborhood suffers from it. Of course, the bank would pay the cost eventually given that it would cost money to fully fix up the house or demolish it in the longer term. But at the short term, the bank does not care and the neighborhood suffers. And this is a terrible loss for the bank and the neighborhood.

From freedigitalphotos.net

So how can this issue be resolved?

1. Change the laws so that the bank takes care of the foreclosed house. This sounds ideal but  maybe problematic legally due to the foreclosure laws.

2. Let the neighbors take care of it. This is also problematic because the neighbors should not really be on the hook and it might be quite costly for them as well.

3. Let the bank and the neighborhood workout a deal. Yes, the classical Coase style, where the two parties negotiate to maximize their utilities. One might argue that the bank might have the upper hand given their expertise and money but I believe that this is a better solution than the previous two solutions. Yes, the bank may be better at negotiating but they will have to consider the welfare of the neighborhood as well, in order to maximize its own utility. Plus, some neighborhood associations are quite organized and strong. An example of an efficient solution may be like an agreement where the neighborhood takes care of the house  and the bank gives part of its proceeds of selling the house later to the neighbors. Of course, the devil is the in the details but this solution seems more effective than having the foreclosed house disintegrate.