Mortgage Default during the U.S. Mortgage Crisis

Abstract

Which theory can quantitatively explain the rise in mortgage defaults during the U.S. mortgage crisis? This paper finds that the double‐trigger hypothesis, which attributes mortgage default to the joint occurrence of negative equity and a life event such as unemployment, is consistent with the evidence. By contrast, a traditional frictionless default model strongly overpredicts the increase in default rates. This paper provides microfoundations for double‐trigger behavior in a model where unemployment causes liquidity problems for the borrower. This framework implies that mortgage crises may be mitigated at a lower cost by bailing out borrowers instead of lenders.

Can’t Pay or Won’t Pay? Unemployment, Negative Equity, and Strategic Default

“… See Laufer (2012) andSchelkle (2011) for theoretical models which allow for strong attachment to homes or aversion to renting.…”

The Homeownership Experience of Minorities During the Great Recession

“…The default decision is attributed to the joint occurrence of an underwater loan and a negative income shock to the household (i.e., a job loss, an illness, or a divorce). The view has been encapsulated in Campbell and Cocco (2015), Gerardi et al (2015), and Schelkle (2014). Most recently, Garriga and Hedlund (2016) argue that a future default could occur even among sellers with positive equity who face selling delays and are unable to sell the house at a reasonable price influenced by their outstanding debt.…”

The Impact of Repossession Risk on Mortgage Default

“…In line with this view, recent empirical research shows that large costs of default are required to match the aggregate or available micro data from the U.S. default crisis (Gerardi et al. (2017), Laufer (2018), Schelkle (2018)). Substantial default costs therefore act as a constraint on mortgage defaults during a recession, when prices and/or incomes fall.…”

“…Standard models of mortgage default, known as "double-trigger" models, demonstrate that borrowers will default if the intrinsic financial value of their mortgage does not exceed the costs of defaulting. 3 In line with this view, recent empirical research shows that large costs of default are required to match the aggregate or available micro data from the U.S. default crisis (Gerardi et al (2017), Laufer (2018), Schelkle (2018)). Substantial default costs therefore act as a constraint on mortgage defaults during a recession, when prices and/or incomes fall.…”