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new working paper “Why Do Borrowers Default on Mortgages? A New Method For Causal Attribution” with @pascaljnoel
Two theories for why:
1) strategic
2) life events
For 30 years, economists have been trying to answer this question
https://www.nber.org/papers/w27585
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abstract
In housing crises, many borrowers who are underwater (owe more on their mortgage than their house is worth) stop making payments. Why?
1) “strategic”: their home is a bad financial investment.
2) triggered by a “life event”, such as the loss of a job, illness, or divorce
1) “strategic”: their home is a bad financial investment.
2) triggered by a “life event”, such as the loss of a job, illness, or divorce
There’s a great speech by Fed Chair @benbernanke from May 2008 where he describes these two theories and how it’s hard to tease them apart. https://www.federalreserve.gov/newsevents/speech/Bernanke20080505a.htm
If you read the popular press in the last recession, reporters told the stories of both strategic default and life event default. So which was more important?
Theory 1 (strategic) https://www.nytimes.com/2010/02/03/business/03walk.html @davidstrei
Theory 1 (strategic) https://www.nytimes.com/2010/02/03/business/03walk.html @davidstrei
Theory 2 (life event)
https://www.nytimes.com/2009/05/25/business/economy/25foreclose.html by @jackhealyNYT @petersgoodman
https://www.nytimes.com/2009/05/25/business/economy/25foreclose.html by @jackhealyNYT @petersgoodman
This is really hard to figure out because of a data problem. Your mortgage servicer doesn’t know what’s happening in your life!
We can make progress on this b/c JPMC Institute data capture both mortgage servicing and *income* (a measure of life events) via bank accounts
We can make progress on this b/c JPMC Institute data capture both mortgage servicing and *income* (a measure of life events) via bank accounts
We provide conditions under which income can be used to provide a causal interpretation of motivations for default.
We find that only 3% of defaults are strategic (driven solely by negative equity), an estimate much lower than prior work.
We find that only 3% of defaults are strategic (driven solely by negative equity), an estimate much lower than prior work.
Why is our estimate so much lower? The data are key. With a coarse measure of life events (as in prior work), researchers may inadvertently overstate the role of strategic default.
The result holds for every type of heterogeneity we can measure, including:
* how far underwater the borrower is
* year of default
* severity of default
* full distribution of income change
* how far underwater the borrower is
* year of default
* severity of default
* full distribution of income change
This finding is very surprising from the perspective of macro models, because most existing models have strategic default as the leading motive. Thus, they predict little income drop among deeply underwater defaulters. We show this using a model from Campbell and Cocco (2015)
Our findings can be used as a tool for macroeconomists who want to model mortgage default in a realistic way, where income losses play a central role in the decision to default.
They also have policy implications for the covid crisis. Because income drops cause default, policies like forbearance will prevent defaults. One of the unsung successes thus far is that aggressive forbearance policies have prevented even larger increases in defaults.
Bottom line: homeowners don’t coldly treat their homes like a financial asset. They act as if defaulting is costly, and for the most part only do so when something bad happens in their financial life that reduces the cash available to make their payments.
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Many folks on econtwitter gave us helpful feedback on this project including @Key_Z_E @nealemahoney @profsufi @ProfNoto @arpitrage @itonomics
Thanks also to @jialanw who started a discussion about our paper with @CFCamerer @profiverson @BetseyStevenson @paulgp @steventberry
