New Research Reveals One-Quarter of Mortgage Defaults Are Strategic

New research released last week by the ""University of Chicago Booth School of Business"":http://www.chicagobooth.edu/ and the ""Kellogg School of Management at Northwestern University"":http://www.kellogg.northwestern.edu/ in Evanston, Illinois, suggests that a novel phenomenon is at hand in the fallout of today's housing crisis - strategic default on mortgage loans.
According to the researchers, given that homes in many markets have lost more than 30 to 40 percent of their value, a growing number of homeowners say they would simply walk away from their loans, without fear of repercussion. Based on data collected from surveys conducted within the last six months as part of the universities' ""Financial Trust Index"":http://www.financialtrustindex.org/ , the researchers estimate that more than a quarter of defaults on mortgage loans are strategic, especially when home values have fallen by more than 15 percent.
The research project was led by Paola Sapienza, Kellogg School of Management at Northwestern University, and Luigi Zingales, University of Chicago Booth School of Business - both co-authors of the quarterly Chicago Booth/Kellogg School Financial Trust Index - as well as Luigi Guiso with the European University Institute. Their paper, entitled """"Moral and Social Restraints to Strategic Default on Mortgages"":http://www.financialtrustindex.org/images/Guiso_Sapienza_Zingales_StrategicDefault.pdf,"" finds that a disturbing number of American homeowners are inclined to purposely default when the value of their mortgage exceeds the value of their house, even if they can afford to make the mortgage payments.
The researchers say that the Obama administration's housing policy has been largely influenced by a study of the Boston housing market during the 1990-91 recession, in which homes devalued by approximately 10 percent. This study found that very few people who could afford their mortgage chose to walk away from their homes. The new research issued last week confirms this claim that homeowners refrain from defaulting as long as negative equity does not exceed the 10 percent mark.
After that level, however, it shows that homeowners start to default at an increasing pace, and walk away massively after decreases of 15 percent or more. In fact, the researcher say 17 percent of households would default, even if they can afford to pay their mortgage, when the equity shortfall reaches 50 percent.
Sapienza commented, ""Housing policy under the current administration has focused on reducing households' cash flow problems in response to the housing crisis, but no one has addressed the negative equity issue as part of public policy regarding housing. We're in a completely different economic environment today, where for the first time since the Great Depression millions of Americans have mortgage loans that exceed the value of their home.""
Sapienze and his colleagues say moral and social variables play a significant role in predicting strategic default. People surveyed who said it was immoral to default were 77 percent less likely to declare their intention to do so, while people who know someone who defaulted were 82 percent more likely to say they would default themselves.
According to Zingales, the social pressure not to default is weakened when homeowners live in areas of high foreclosures or know others who defaulted strategically. He said, ""The predisposition to default increases with the number of foreclosures in the same ZIP code.""
The researchers also noted that mortgage default is considered less morally wrong in the Northeast and Western regions of the country. They said that homeowners under the age of 35 and over the age of 65 were less likely to say it was morally wrong to default compared to middle-aged respondents, and respondents who supported government intervention to help homeowners were also less likely to say strategic default is immoral.
Sapienza added, ""As defaults become more common, the social stigma attached with defaulting will likely be reduced, especially if there continues to be few repercussions for people who walk away from their loans. This has an adverse effect on homeowners who do pay their mortgages, and the after-effects of more defaults and more price collapse could be economic catastrophe.""