A central question in the literature on mortgage default is at what point underwater homeowners walk away from their homes even if they can afford to pay. We study borrowers from Arizona, California, Florida, and Nevada who purchased homes in 2006 using non-prime mortgages with 100 percent financing. Almost 80 percent of these borrowers default by the end of the observation period in September 2009. After distinguishing between defaults induced by job losses and other income shocks from those induced purely by negative equity, we find that the median borrower does not strategically default until equity falls to-62 percent of their home's value. This result suggests that borrowers face high default and transaction costs. Our estimates show that about 80 percent of defaults in our sample are the result of income shocks combined with negative equity. However, when equity falls below-50 percent, half of the defaults are driven purely by negative equity. Therefore, our findings lend support to both the "double-trigger" theory of default and the view that mortgage borrowers exercise the implicit put option when it is in their interest.

What caused the housing boom of the 2000s? A number of researchers have suggested that loose monetary policy during the first half of the 2000s was a primary cause of the substantial run-up in house prices in many countries. However, using a common statistical approach, we find that monetary policy was not the main factor. That should not be surprising: Although low interest rates raise house prices, the increase in prices during the mid-2000s was much larger than the historical relationship between the two variables would suggest. Instead, we investigate further the link between the marked loosening in terms and standards for mortgage credit and the most rapid increases in house prices. This link provides some evidence for a story where credit provision and the demand for housing fed on each other and helped spur the housing boom. Our work suggests a greater role for macroprudential regulation rather than monetary policy in managing asset price booms.

From 2007 to 2009 U.S. house prices plunged and mortgage defaults surged. While ostensibly consistent with widespread “ruthless default,” analysis of detailed mortgage and house price data indicates that borrowers do not walk away until they are deeply underwater—far deeper than traditional models predict. The evidence suggests that lender recourse is not the major driver of this result. We argue that emotional and behavioral factors play an important role in decisions to continue paying. Borrower reluctance to walk away implies that the moral hazard cost of default as a form of social insurance may be lower than suspected.