Tag Archives: strategic default

How does negative housing equity interact with the decision to default?

Screenshot 2014-07-18 11.25.06

 

Michael Seiler thinks it might be this way… see his paper below for more details.

 

Seiler, Michael Joseph, Determinants of the Strategic Mortgage Default Cumulative Distribution Function (June 20, 2014). Available at SSRN: http://ssrn.com/abstract=2465059 orhttp://dx.doi.org/10.2139/ssrn.2465059

 

 

 

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Strategic Mortgage Default: What does the research tell us?

keysWhat do we know about strategic (could meet obligations but choose not to ) defaulters in relation to mortgages?

As I argued earlier, in the Irish case very little is known. There is a little more information for the USA, but we should be very careful about blindly or even carefully transposing US experience to Ireland. The legal, cultural, economic and social climates are very different. We seem to be more tolerant of default than the USA but beyond that…That said, here are what I see as the present state of play. Im sure I have missed some research but for what its worth…

  • As few as 15% of US defaults might be strategic (Gerardi et al. 2013) . Or it might be higher (but the methodology (Guiso, Sapienza, and Zingales 2011) used is to ask people, in effect, if they know someone who they think could have repaid but didn’t…) at around 25%. If its not 1/3 or more in the USA with more liberal bankruptcy and recourse laws then is it credible that it is 1/3 here?
  • People feel regret but not shame when they default (M J Seiler et al. 2012). There is a massive ‘fear factor’ on which lenders play, as well as asymmetrical fears of moral hazard (White 2010c).
  • Default is not just an individual but also a  social phenomena and there can be “herding” in defaults (M J Seiler, Lane, and Harrison 2012). This is perhaps an under researched area.
  • The bankruptcy code really matters with lower rates the easier it is to strategically default (Edmonds, Stevenson, and Swisher 2011)
  • The more you repossess the less a stigma it is and the more likely people are to strategically default (Wilkinson-Ryan 2011). The law of unintended consequences therefore suggests that if we move to  a significantly more aggressive repossession culture we will see cascades of defaults with the consequent knocking back of property prices and erosion of bank balance sheets…. be careful for what you wish.
  • Less information about the process is useful from the perspective of the lender in reducing the incidence of default (M J Seiler 2013). Theres no doubt that the Irish system is opaque, and perhaps deliberatly so.
  • Amongst lower income US households most defaults are not strategic. (Riley 2013)
  • There’s a contract between the lender and the borrower but even in law there can be a ranking of contracts and the social/familial contract supersedes this other contract allowing for default. (White 2010b).
  • Many defaults precipitate not from rational but from emotional decisions, thus reducing the emotional crises points can and does reduce default (White 2010a). Most people want a fair deal, which allows them to continue servicing debts at a reasonable rate but with certainty about where the future lies.
  • People don’t default, strategically or otherwise, until they are deeply underwater, typically negative equity of 67%  are required in the USA. (Bhutta, Dokko, and Shan 2011)
  • Oh, and some people might be neurologically more inclined to default than others…( Seiler, Walden, and Lane 2012). Might we see MRI scans as well as payslips being required in future before mortgages are approved?

Bhutta, Neil, Jane K. Dokko, and Hui Shan. 2011. “Consumer Ruthlessness and Mortgage Default During the 2007-2009 Housing Bust.” SSRN Electronic Journal (December 31). doi:10.2139/ssrn.1626969. http://papers.ssrn.com/abstract=1626969.

Edmonds, T N, L J Stevenson, and J Swisher. 2011. “Forgive Us Our Debts: The Great Recession of 2008-09.” Journal of Legal, Ethical and Regulatory Issues 14 (2): 1–16. http://www.scopus.com/inward/record.url?eid=2-s2.0-84863525338&partnerID=40&md5=cc9d8b72b8b94a96ca05b675fccb4560.

Gerardi, Kristopher, Kyle Herkenhoff, Lee E. Ohanian, and Paul Willen. 2013. “Unemployment, Negative Equity, and Strategic Default.” http://papers.ssrn.com/abstract=2293152.

Guiso, Luigi, Paola Sapienza, and Luigi Zingales. 2011. “The Determinants of Attitudes Towards Strategic Default on Mortgages.” SSRN Electronic Journal (March 1). doi:10.2139/ssrn.1573328. http://papers.ssrn.com/abstract=1573328.

Riley, Sarah F. 2013. “Strategic Default Behavior and Attitudes Among Low-Income Homeowners” (February 1). http://papers.ssrn.com/abstract=2282518.

Seiler, M J. 2013. “The Role of Informational Uncertainty in the Decision to Strategically Default.” SSRN Electronic Journal (January 29). doi:10.2139/ssrn.2211933. http://papers.ssrn.com/abstract=2211933.

Seiler, M J, M A Lane, and D M Harrison. 2012. “Mimetic Herding Behavior and the Decision to Strategically Default.” Journal of Real Estate Finance and Economics. Old Dominion University, College of Business Administration, Norfolk, 23529-0223, United States. http://www.scopus.com/inward/record.url?eid=2-s2.0-84866282494&partnerID=40&md5=bd88e45d25c19dc9afd2a035c384852b.

Seiler, M J, V L Seiler, M A Lane, and D M Harrison. 2012. “Fear, Shame and Guilt: Economic and Behavioral Motivations for Strategic Default.” Real Estate Economics 40 (SUPPL. 1): S199–S233. http://www.scopus.com/inward/record.url?eid=2-s2.0-84871824267&partnerID=40&md5=cc8149feb524d374946f70929bc874fa.

Seiler, Michael Joseph, Eric A. Walden, and Mark Lane. 2012. “Strategic Mortgage Default and the Decision to Follow the Herd: A Neurological Explanation.” SSRN Electronic Journal (December 27). doi:10.2139/ssrn.2194254. http://papers.ssrn.com/abstract=2194254.

White, Brent T. 2010a. “Take This House and Shove It: The Emotional Drivers of Strategic Default.” SSRN Electronic Journal (May 14). doi:10.2139/ssrn.1603605. http://papers.ssrn.com/abstract=1603605.

———. 2010b. “The Morality of Strategic Default.” SSRN Electronic Journal (May 22). doi:10.2139/ssrn.1597835. http://papers.ssrn.com/abstract=1597835.

———. 2010c. “Underwater and Not Walking Away: Shame, Fear and the Social Management of the Housing Crisis.” SSRN Electronic Journal (October 27). doi:10.2139/ssrn.1494467. http://papers.ssrn.com/abstract=1494467.

Wilkinson-Ryan, T. 2011. “Breaching the Mortgage Contract: The Behavioral Economics of Strategic Default.” Vanderbilt Law Review 64 (5): 1547–1583. http://www.scopus.com/inward/record.url?eid=2-s2.0-81855184667&partnerID=40&md5=4546d2ad8953dfd098aacad6d2fadffc.

Strategic Defaults in Irish Mortgages – What do and dont we know?

Irish residential and Buy to let mortgages are in a mess. The latest Central Bank data indicate that by value 16.5% of all residential mortgages are in arrears accounting for 12.3% of all mortgages. The charts below show the evolution of this situation. Note that these are only for residential mortgages. Buy to Let are a separate problem, and are commercial loans that if in default should be foreclosed on. There may well be an issue with cross collaterisation of these to residential but again thats a separate issue.

marrears2 MArrears

One of the issues that arises is “strategic default”, that is to say how many of these 142,000 mortgages in arrears are “wont pay” rather than “cant pay”. The simple answer is we do not know. That doesn’t stop the assumption that “its a lot”. Today we see in an otherwise excellent discussion by Davy stockbrokers on the banks the statement ” A growing culture of strategic non-payment of debt “.  How do they know its growing? From what base? To what level?

The meme is that its 1/3 of arrears in default are “Strategic” , Wont Pay defaulters. This arises from a post by Professor Gregory Connor where he took US studies and tried to map the findings to Ireland. This is a difficult and thankless task but absent anything else its all we have.

In a parliamentary reply to a question on this issue the Minister for Finance stated his view (aka the Department of Finance view) on the 1/3 figure as ” The suggestion that the rising number of mortgage arrears is in part being driven by increased levels of strategic default, that is individuals deliberately withholding payments when they are in a position to service their debt in hope of gaining concessions from lenders, is wholly anecdotal and not based on any robust, structured, or in-depth analysis of the situation” 

This then begs the question : where is this analysis? So far as I am aware there is none. A proper analysis of the issue of strategic or wont pay default would require the following, I contend.

  • a survey of all defaulters, or a representative sample thereof.
  • While this  survey would  have to originate from the issuing lenders it would have to be 100% clear and bulletproofed that no information whatsoever would return back from the analysis to the lender such that individual borrowers could be identified. Thus in all probability no official body should carry out the analysis or interpretation
  • defaulters would need to be queried as to their present expenditure habits , with a view to ascertaining whether they were strategic and if so how and why
  • to what extent are borrowers strategic in placing other loan repayments before mortgages or are they defaulting on many loans and using funds for ongoing living expenses
  • to what extent are they not repaying due to pressure, either lack of same from the mortgage lenders or relatively greater from other
  • the extent to which social and other pressures impact ; there is a good recent paper on this in SSRN

Now, it may be that this is already underway. But if its not then it should be. I am perfectly happy to undertake this research pro-bono, and I am sure that other academics would help. This information, the bare knowledge of who is defaulting and why, needs to be surfaced.  We cannot devise strategies if we dont know the problem. We cant simply map the situation in the USA, with wildly different legal and economic systems, to Ireland.