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In Which I Come Back To Walk-aways...

Since I spent a fair bit of space trying to bat down concerns that the U.S. is being overrun by mortgage walkers, I should address a recent study picked up by the WSJ and Time which found that up to "26% of the existing defaults are strategic."

To my mind, the biggest problem with the study (conducted by Luigi Guiso of the European University Institute, Paola Sapienza of Northwestern, and Luigi Zingales of the University of Chicago) is that it's based on survey data, so the findings need to be taken with a grain of salt. That's largely because people are bad at predicting their own future behavior and/or don't always tell the truth to survey questioners. A recent example of this was what people said they did with their 2001 stimulus checks. An early study based on surveys found that people said they spent only one-third of their checks while two following studies--one using credit card data--found that recipients wound up spending over two-third's of their checks.

In the current study, the authors argue that past research by the Boston Fed showing few instances of walk aways isn't relevant for the current housing bust. That's primarily because the real estate downturn studied by the Boston Fed-- Massachusetts in the early 1990's--was very small comparable to the current one. Guiso, Sapienza, and Zingales think that with bigger housing price declines we should see more strategic defaults.

So, they asked survey respondents if they would default if they owed $50,000 more than their homes were worth. Nine percent answered affirmatively. They then asked those respondents who said no: what if your home was $100K underwater. Another 26% of these people said yes. To put this in perspective, the peak median home price in the U.S. was $247,900 in 2007, according to the Census Bureau. Prices have fallen an average of about 30% since then, or roughly $75,000, so if prices fall another ten percent we should see a big surge in walkaways in the coming months. 

The researchers also asked respondents if they knew someone who had defaulted, and if they knew someone who had walked away:

By taking a ratio between the answer to the second and the first question, we get an estimate of the percentage of default that is considered strategic. We obtain that 26% of the observed defaults are considered strategic.

While those are two significant pieces of evidence against my argument that walk-aways aren't widespread, I find it surprising that there's such a big disparity between what respondents say they would themselves do and what they report observing. If 26% of current defaults are strategic, why did only 9% of the initial respondents say they would walk away? Perhaps the average person who defaults is well more than $50,000 underwater. More likely, it points to the weakness of surveys. 

The researchers also looked at the home values of survey respondents who said they would consider a strategic default and found that between 0 and 7% would default if they were 10% underwater and 17-25% would default if they were 50-60% underwater. This also doesn't quite jibe with 26% of current defaults being strategic. If the respondents follow through on their answers and home prices fall 50-60% (which is above the gloomiest of current forecasts), then we'll see a quarter of defaults being walk aways.

Another question worth asking (as many commenters did on my last post), is where do all these people who walked away--and didn't have second homes--go after they left their houses? One place you might expect them to show up is in rentals, but that doesn't seem to be the case: Vacancies are at a 22-year high in the apartment market. 

But let's say for argument's sake that 26% of defaults are indeed from people who could afford to pay their mortgages. How concerned should we be? Well, the majority of defaults would still be a result of financial hardship and mortgage-holders not having enough money to pay their monthly bill. So, to me, the policy implications don't really change: If you want to tackle the foreclosure problem, seeking more ways to reduce monthly payments is where it's at. On that front, we know that loan modifications are not working, so perhaps a wider bailout of homeowners could be part of a second stimulus, or we could revisit the failed cram-down bill. It doesn't sound appetizing to bailout people who made bad decisions, but not doing so could be counterproductive, since, as Calculated Risk pointed out a while back, economic recoveries are typically coincident with bouyant housing markets.  

--Zubin Jelveh