Unemployment, Negative Equity, and Strategic Default

Kristopher Gerardi, Kyle F. Herkenhoff, Lee E. Ohanian, and Paul S. Willen
Working Paper 2013-4
August 2013

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Using new household-level data, we quantitatively assess the roles that job loss, negative equity, and wealth (including unsecured debt, liquid assets, and illiquid assets) play in default decisions. In sharp contrast to prior studies that proxy for individual unemployment status using regional unemployment rates, we find that individual unemployment is the strongest predictor of default. We find that individual unemployment increases the probability of default by 5–13 percentage points, ceteris paribus, compared with the sample average default rate of 3.9 percent. We also find that only 13.9 percent of defaulters have both negative equity and enough liquid or illiquid assets to make one month's mortgage payment. This finding suggests that "ruthless" or "strategic" default during the 2007–09 recession was relatively rare and that policies designed to promote employment, such as payroll tax cuts, are most likely to stem defaults in the long run rather than policies that temporarily modify mortgages.

JEL classification: E24, E30, G21, E60, D12, D14, E51, G33, L85, R31

Key words: unemployment, mortgage, default, strategic default, negative equity, liquidity constraint

This paper previously circulated under the title "What Actually Causes Mortgage Defaults, Redefaults, and Modifications," available on February 2, 2012, at ssrn.com/abstract=1997890. Herkenhoff thanks the Ziman Center for funding. The views expressed here are the authors' and not necessarily those of the Federal Reserve Banks of Atlanta or Boston or the Federal Reserve System. Any remaining errors are the authors' responsibility.

Please address questions regarding content to Kristopher Gerardi, Research Department, Federal Reserve Bank of Atlanta, 1000 Peachtree Street, N.E., Atlanta, GA 30309-4470, 404-498-8561, kristopher.gerardi@atl.frb.org; Kyle F. Herkenhoff, Department of Economics, University of California-Los Angeles, 8283 Bunche Hall, Los Angeles, CA 90095-1477, 310-825-1011, kfh@ucla.edu; Lee E. Ohanian, University of California-Los Angeles and Center for the Advanced Study in Economic Efficiency, Arizona State University, Department of Economics, 405 Hilgard Avenue, Los Angeles, CA 90024, 310-825-0979, ohanian@econ.ucla.edu; or Paul S. Willen, Research Department, Federal Reserve Bank of Boston, 600 Atlantic Avenue, Boston, MA 02210-2204, 617-973-3149, paul.willen@bos.frb.org

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