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Mortgage Default during the U.S. Mortgage Crisis

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  • Thomas Schelkle

    (London School of Economics)

Abstract

This paper asks which theories of mortgage default are quantitatively consistent with observations in the United States during 2002-2010. Theoretical models are simulated for the observed time-series of aggregate house prices. Their predictions are then compared to actual default rates on prime fixed-rate mortgages. An out-of-sample test discriminates between estimated reduced forms of the two most prominent theories. The test reveals that the double-trigger hypothesis attributing mortgage default to the joint occurrence of negative equity and a life event like unemployment outperforms a frictionless option-theoretic default model. Based on this finding a structural partial-equilibrium model with liquidity constraints and idiosyncratic unemployment shocks is presented to provide micro-foundations for the double-trigger hypothesis. In this model borrowers with negative equity are more likely to default when they are unemployed and have low liquid wealth. The model explains most of the observed strong rise in mortgage default rates. A policy implication of the model is that subsidizing homeowners can mitigate a mortgage crisis at a lower cost than bailing out lenders.

Suggested Citation

  • Thomas Schelkle, 2012. "Mortgage Default during the U.S. Mortgage Crisis," 2012 Meeting Papers 751, Society for Economic Dynamics.
  • Handle: RePEc:red:sed012:751
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    References listed on IDEAS

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    Cited by:

    1. Andreas Fuster & Paul S. Willen, 2017. "Payment Size, Negative Equity, and Mortgage Default," American Economic Journal: Economic Policy, American Economic Association, vol. 9(4), pages 167-191, November.
    2. Aaron Hedlund & Carlos Garriga, 2016. "Mortgage Debt, Consumption, and Illiquid Housing Markets in the Great Recession," 2016 Meeting Papers 1564, Society for Economic Dynamics.
    3. Foote, Christopher L. & Willen, Paul S., 2017. "Mortgage-default research and the recent foreclosure crisis," Working Papers 17-13, Federal Reserve Bank of Boston.
    4. Gerardi, Kristopher & Herkenhoff, Kyle F. & Ohanian, Lee E. & Willen, Paul S., 2013. "Can't Pay or Won't Pay? Unemployment, Negative Equity, and Strategic Default," FRB Atlanta Working Paper 2013-04, Federal Reserve Bank of Atlanta, revised 01 Jun 2017.

    More about this item

    JEL classification:

    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • D11 - Microeconomics - - Household Behavior - - - Consumer Economics: Theory

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