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Fed vs Fed on strategic mortgage default during the financial crisis

Summary:
Suppose you borrowed a lot of money to buy a house but now find it’s worth a lot less than you currently owe. If your lenders only have recourse to the house itself, you might have good reason to stop paying your debts and walk away — even if you’re perfectly capable of making continued payments.After all, your credit rating will take a hit but your net worth will improve significantly as you move from negative home equity to zero home equity. You might also save money by moving somewhere else with lower monthly payments. Since you never lost the ability to pay your debts, only the willingness to do so, your default would be “strategic”.A few years ago, economists from the Federal Reserve banks of Atlanta and Boston wrote an influential paper trying to quantify the importance of these “strategic” defaults. They found that 14 per cent of all the people who stopped paying their mortgages in 2007-9 had “both negative equity and enough liquid or illiquid assets to make 1 month’s mortgage payment”. In their view, this meant that strategic default was a “relatively rare” phenomenon and “not a major factor” compared to people defaulting because they were simply unable to pay.Their own data didn’t unequivocally support that conclusion, however.

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Suppose you borrowed a lot of money to buy a house but now find it’s worth a lot less than you...

Matthew C Klein
I write about the economy and financial markets for Bloomberg View. Before that I wrote for The Economist. I have worked at the world’s largest hedge fund and read every FOMC transcript since May, 1987

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