This paper reviews recent research on mortgage default, focusing on the relationship of this research to the recent foreclosure crisis. Research on defaults was advanced both theoretically and empirically by the time the crisis began, but economists have moved the frontier further by improving data sources, building dynamic optimizing models of default, and explicitly addressing reverse causality between rising foreclosures and falling house prices. Mortgage defaults were also a key component of early research that pointed to subprime and other privately securitized mortgages as fundamental drivers of the housing boom, although this research has been criticized recently. Going forward, improvements to data and models will allow researchers to explore the central unsolved question in this area: why mortgage default is so rare, even for households with high levels of negative equity or financial distress.
This paper is a welcome corrective to the assumption that borrowers would “strategically” default on mortgages by showing that defaults were rare even when the home had negative equity, finding that most were “double trigger” defaults, where negative equity was coupled with some other financial distress, such as job loss.
The article is also very candid regarding how mortgage servicers were loath to grant any principal reductions during the housing crisis, out of a “reputational” fear that more borrowers would expect similar decent and humane treatment. Perhaps if mortgage servicers were themselves subject to the market pressures of homeowner choice, rather than pure fiat from investors, they would be concerned about their reputation as quality servicers.
Lastly, the article completely ignores the option of using bankruptcy to sort the “strategic” defaulters from the truly “honest but unfortunate” debtors, not mentioning it or the judicial mortgage modification proposals at all.