In the current edition of The Economist magazine, the article: Can pay, won’t pay with subtitle “It is easier to dump a home loan if a friend has done so too” discusses the paper Moral and Social Constraints to Strategic Default on Mortgages.

Here are the results:

  • 26% of the existing defaults are strategic.
  • No household would default if the equity shortfall is less than 10% of the value of the house.
  • 17% of households would default, even if they can afford to pay their mortgage, when the equity shortfall reaches 50% of the value of their house.

Anger about bail-outs of banks or carmakers does not weaken the moral barrier to default. But people who live in neighbourhoods where home repossessions are frequent are more likely to welsh on loans. Homeowners who know someone who has defaulted strategically are 82% more likely to say they would do so, too. The likelihood of strategic default rises more quickly once the rate of local home foreclosures reaches a critical level. That hints at a vicious cycle of foreclosures that both depress home prices and weaken the social and economic barriers to further defaults. To break the cycle, policymakers need to address the problem of negative equity, not just unaffordable interest payments.

“Speaking of” carmaker bailouts and being strategic: My wife’s family has a long heritage associated with Detroit and the auto industry. To brush up before their visit this week, I listened to this fantastic discussion about the crazy auto franchise system – closing the dealerships as part of the bailout never made sense to me – now it does. Have a listen.



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