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Your house or your credit card, which would you choose?: personal delinquency tradeoffs and precautionary liquidity motives

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Author Info

  • Ethan Cohen-Cole
  • Jonathan Morse

Abstract

This paper finds strong evidence that many individuals choose to pay credit card bills even at the cost of mortgage delinquencies and foreclosures. While the popular press and some recent literature have suggested that this choice may emerge from steep declines in housing prices, we find evidence that individual-level liquidity concerns are at least as important in the decision. That is, choosing credit cards over housing suggests a precautionary liquidity preference. ; By linking the mortgage delinquency decisions to individual-level credit conditions, we are able to assess the compound impact of reductions in housing prices and retrenchment in the credit markets. Indeed, we find the availability of cash-equivalent credit to be a key component of the default decision. We find that a one standard deviation reduction in housing price changes elicits a change in the predicted probability of mortgage default that is similar in both direction and magnitude to a one standard deviation reduction in available credit (the values are -14.9% and -13.1% respectively). Availability of consumer credit appears important not only as a means of payment, but also as an insurance mechanism for individuals and a shock absorber for the economy as a whole. Our findings are consistent with consumer finance literature that finds individuals have a preference for preserving liquidity - even at significant cost.

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File URL: http://www.bostonfed.org/bankinfo/qau/wp/2009/qau0905.htm
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File URL: http://www.bostonfed.org/bankinfo/qau/wp/2009/qau0905.htm
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Bibliographic Info

Paper provided by Federal Reserve Bank of Boston in its series Risk and Policy Analysis Unit Working Paper with number QAU09-5.

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Date of creation: 2009
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Handle: RePEc:fip:fedbqu:qau09-5

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Related research

Keywords: Finance; Personal ; Credit cards ; Liquidity (Economics) ; Mortgage loans;

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Cited by:
  1. Stefan Trautmann & Razvan Vlahu, 2011. "Strategic Loan Defaults and Coordination: An Experimental Analysis," DNB Working Papers 312, Netherlands Central Bank, Research Department.
  2. Ronel Elul & Nicholas S. Souleles & Souphala Chomsisengphet & Dennis & Glennon & Robert Hunt, 2010. "What "triggers" mortgage default?," Working Papers 10-13, Federal Reserve Bank of Philadelphia.
  3. Donghoon Lee & Christopher Mayer & Joseph Tracy, 2012. "A new look at second liens," Staff Reports 569, Federal Reserve Bank of New York.
    • Donghoon Lee & Christopher Mayer & Joseph Tracy, 2012. "A New Look at Second Liens," NBER Chapters, in: Housing and the Financial Crisis, pages 205-234 National Bureau of Economic Research, Inc.
  4. Christopher J. Mayer & Edward Morrison & Tomasz Piskorski & Arpit Gupta, 2011. "Mortgage Modification and Strategic Behavior: Evidence from a Legal Settlement with Countrywide," NBER Working Papers 17065, National Bureau of Economic Research, Inc.

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