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Negative equity and foreclosure: Theory and evidence

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Author Info
Foote, Christopher L.
Gerardi, Kristopher
Willen, Paul S.

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Abstract

Recent declines in housing prices have focused attention on the relationship between negative housing equity and mortgage default. Theory implies that negative equity is a necessary condition for default, but not a sufficient one. This often-misunderstood result is clearly illustrated in a dataset of Massachusetts homeowners during the early 1990s; fewer than 10 percent of borrowers likely to have had negative equity at the end of 1991 experienced a foreclosure during the following three years. An econometric model of default estimated on two decades of Massachusetts housing data also predicts low default rates for current negative-equity borrowers. We develop a simple theoretical model to interpret these empirical findings and to assess potential foreclosure-reduction policies. Our results imply that lenders and policymakers face an information problem in trying to help borrowers with negative equity, because it is hard to determine which owners really need help in order to stay in their homes.

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File URL: http://www.sciencedirect.com/science/article/B6WMG-4T2M5SG-1/2/f69441d0ed3deeb014be97f552ce5b7c
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Publisher Info
Article provided by Elsevier in its journal Journal of Urban Economics.

Volume (Year): 64 (2008)
Issue (Month): 2 (September)
Pages: 234-245
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Handle: RePEc:eee:juecon:v:64:y:2008:i:2:p:234-245

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Web page: http://www.elsevier.com/locate/inca/622905

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Kristopher Gerardi & Adam Hale Shapiro & Paul S. Willen, 2007. "Subprime outcomes: risky mortgages, homeownership experiences, and foreclosures," Working Papers 07-15, Federal Reserve Bank of Boston. [Downloadable!]
  2. Kau James B. & Keenan Donald C. & Kim Taewon, 1994. "Default Probabilities for Mortgages," Journal of Urban Economics, Elsevier, vol. 35(3), pages 278-296, May. [Downloadable!] (restricted)
  3. Christopher L. Foote & Kristopher Gerardi & Lorenz Goette & Paul S. Willen, 2008. "Subprime facts: what (we think) we know about the subprime crisis and what we don’t," Public Policy Discussion Paper 08-2, Federal Reserve Bank of Boston. [Downloadable!]
  4. Souphala Chomsisengphet & Anthony Pennington-Cross, 2006. "The evolution of the subprime mortgage market," Review, Federal Reserve Bank of St. Louis, issue Jan, pages 31-56. [Downloadable!]
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(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Christopher Foote & Kristopher Gerardi & Lorenz Goette & Paul Willen, 2009. "Reducing Foreclosures: No Easy Answers," NBER Working Papers 15063, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  2. Luci Ellis, 2008. "How many in negative equity? The role of mortgage contract characteristics," BIS Quarterly Review, Bank for International Settlements, December. [Downloadable!]
  3. Luigi Guiso & Paola Sapienza & Luigi Zingales, 2009. "Moral and Social Constraints to Strategic Default on Mortgages," Economics Working Papers ECO2009/27, European University Institute. [Downloadable!]
    Other versions:
  4. W. Scott Frame & Lawrence J. White, 2009. "Technological change, financial innovation, and diffusion in banking," Working Paper 2009-10, Federal Reserve Bank of Atlanta. [Downloadable!]
  5. Christopher L. Foote & Kristopher Gerardi & Lorenz Goette & Paul S. Willen, 2008. "Subprime facts: what (we think) we know about the subprime crisis and what we don’t," Public Policy Discussion Paper 08-2, Federal Reserve Bank of Boston. [Downloadable!]
  6. Patrick Bajari & Chenghuan Sean Chu & Minjung Park, 2008. "An Empirical Model of Subprime Mortgage Default From 2000 to 2007," NBER Working Papers 14625, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  7. Yuliya Demyanyk, 2009. "Quick exits of subprime mortgages," Review, Federal Reserve Bank of St. Louis, issue Mar, pages 79-94. [Downloadable!]
  8. Andrew Haughwout & Richard Peach & Joseph Tracy, 2008. "Juvenile delinquent mortgages: bad credit or bad economy?," Staff Reports 341, Federal Reserve Bank of New York. [Downloadable!]
    Other versions:
  9. Christopher J. Mayer & Karen M. Pence & Shane M. Sherlund, 2008. "The rise in mortgage defaults," Finance and Economics Discussion Series 2008-59, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
  10. Kristopher S. Gerardi & Paul S. Willen, 2009. "Subprime mortgages, foreclosures, and urban neighborhoods," Working Paper 2009-01, Federal Reserve Bank of Atlanta. [Downloadable!]
  11. Kristopher S. Gerardi & Andreas Lehnert & Shane M. Sherlund & Paul S. Willen, 2009. "Making sense of the subprime crisis," Working Paper 2009-02, Federal Reserve Bank of Atlanta. [Downloadable!]
    Other versions:
  12. W. Scott Frame, 2009. "The 2008 federal intervention to stabilize Fannie Mae and Freddie Mac," Working Paper 2009-13, Federal Reserve Bank of Atlanta. [Downloadable!]
  13. Luci Ellis, 2008. "The housing meltdown: Why did it happen in the United States?," BIS Working Papers 259, Bank for International Settlements. [Downloadable!]
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