Why Do Borrowers Default on Mortgages?
There are three prevailing theories of mortgage default: strategic default (driven by negative equity), cash-flow default (driven by negative life events), and double-trigger default (where both negative triggers are necessary). It has been difficult to test between these theories in part because negative life events are measured with error. We address this measurement error using a comparison group of borrowers with no strategic default motive. Our central finding is that only 6 percent of underwater defaults are caused exclusively by negative equity, an order of magnitude lower than previously thought. We then analyze the remaining defaults. We find that 70 percent are driven solely by negative life events (i.e., cash-flow defaults), while 24 percent are driven by the interaction between negative life events and negative equity (i.e., double-trigger defaults). Together, the results provide a full decomposition of the three theories underlying borrower default and suggest that negative life events play a central role.
We are particularly grateful for many fruitful conversations with Kanav Bhagat that helped shape the analysis in this paper. We thank John Campbell, Joao Cocco, and Marco Giacoletti for generously sharing code and for very helpful comments. We further thank Joao Cocco, Angus Foulis, Amir Kermani, and Paul
Willen for serving as discussants on this paper. We also thank Neil Bhutta, Adam Guren, Kyle Herkenhoff, Peter Hull, Erik Hurst, Koichiro Ito, Anil Kashyap, Ben Keys, David Matsa, Neale Mahoney, Atif Mian, Jack Mountjoy, Mikkel Plagborg-Moller, Matthew Notowidigdo, Christopher Palmer, Jesse Shapiro, Amir Sufi, Joseph Vavra, Robert Vishny, Paul Willen, Luigi Zingales, and Eric Zwick for helpful conversations. We thank seminar participants at AEA, AREUEA, Bank of England, the Becker Friedman Institute, Berkeley Haas, Brown, BYU, the Central Bank of Ireland, Copenhagen University, CUNY, Dartmouth, Duke, Federal Reserve Bank of Boston, FHFA, GBURES, HBS, HEC, IMF, LBS, MFA, Michigan, Minnesota, MIT Sloan, NBER Summer Institute, NYU, the Stanford Institute for Theoretical Economics, TAMU, University of Chicago Law School, and UCLA for helpful comments. We thank Ari Anisfeld, Rei Bertoldi, Therese Bonomo, Guillermo Carranza Jordan, Timotej Cejka, Lei Ma, Roshan Mahanth, Liam Purkey, Peter Robertson, Nicolas Wuthenow, and Katie Zhang for excellent research assistance. This research was made possible by a data-use agreement between the authors and the JPMorgan Chase Institute (JPMCI), which has created de-identified data assets that are selectively available to be used for academic research. All statistics from JPMCI, including medians, reflect cells with at least 10 observations. The opinions expressed are those of the authors alone and do not represent the views of JPMorgan Chase & Co. While working on this paper, the authors were compensated for providing research advice on public reports produced by the JPMCI research team. We gratefully acknowledge the financial support of the Center for Research in Security Prices, the Fama-Miller Center, the Initiative on Global Markets, the Kathryn and Grant Swick Faculty Research Fund, and the Fujimori/Mou Faculty Research Fund at the University of Chicago Booth School of Business. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.