Can't Pay or Won't Pay? Unemployment, Negative Equity, and Strategic Default

Kristopher Gerardi, Kyle F. Herkenhoff, Lee E. Ohanian, and Paul S. Willen

Working Paper 2013-4a
August 2013 (Revised June 2017)

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This paper exploits matched data from the PSID on borrower mortgages with income and demographic data to quantify the relative importance of negative equity, versus lack of ability to pay, as affecting default between 2009 and 2013. These data allow us to construct household budgets sets that provide better measures of ability to pay. We use instrumental variables to quantify the impact of ability to pay, including job loss and disability, versus negative equity. Changes in ability to pay have the largest estimated effects. Job loss has an equivalent effect on default likelihood as a 35 percent decline in equity.

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

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


The authors are grateful for comments by Gene Amromin, Jan Brueckner, Satyajit Chatterjee, Morris Davis, Andra Ghent, John Krainer, Edward Kung, Stuart Gabriel, Erwan Quintin, Joe Tracy, and Rob Valetta as well as for comments from seminar participants at the 2014 FRBSF-Ziman Center Housing Conference, 2014 HULM Conference at FRB Chicago, and 2015 AREUEA. Jaclene Begley and Lara Lowenstein provided excellent research assistance. Herkenhoff thanks the Ziman Center for Real Estate for support. The views expressed here are the authors’ and not necessarily those of the Federal Reserve Bank of Boston, the Federal Reserve Bank of Atlanta, the Federal Reserve Bank of Minneapolis, or the Federal Reserve System. Any remaining errors are the authors’ responsibility.
Please address questions regarding content to Kristopher Gerardi, Federal Reserve Bank of Atlanta, Research Department, 1000 Peachtree Street NE, Atlanta, GA 30309-4470, 404-498-8561, kristopher.gerardi@atl.frb.org; Kyle F. Herkenhoff, University of Minnesota, Department of Economics, 4-173 Hanson Hall, 1925 Fourth Street South, Minneapolis, MN 55455, 612-625-3399, kfh@umn.edu; Lee E. Ohanian, UCLA, Federal Reserve Bank of Minneapolis, NBER, and CASEE, Department of Economics, 405 Hilgard Avenue, Los Angeles, CA 90024, 310-825-0979, ohanian@econ.ucla.edu; or Paul S. Willen, Federal Reserve Bank of Boston and NBER, Research Department, 600 Atlantic Avenue, Boston, MA 02210-2204, 617-973-3149, paul.willen@bos.frb.org
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