Fear, Shame and Guilt: Economic and Behavioral Motivations for Strategic Default

Abstract

This study examines underwater primary resident homeowners to identify why some decide to strategically default while others do not. We find that realized shame and guilt are consistent with ex ante expectations. However, the financial backlash experienced by strategic defaulters is less than anticipated, causing strategic defaulters not to regret their actions. State‐specific bankruptcy exemption levels and real estate laws only marginally explain the decision to strategically default, partly because the decision to walk away from a mortgage is emotional, and partly because the implementation of these laws is uncertain and confusing to distressed borrowers. Rather, we find key strategic default drivers include the homeowner's expectation of future real estate price movements, frustration with the lender, moral evaluation of the decision to strategically default, loan knowledge, political ideology, gender, income and age.

A Neurological Explanation of Strategic Mortgage Default

“…Red corresponds to a voxel with a z-score of 1.96 and yellow to a z-score of 5. , Sapienza, and Zingales (2013) and Seiler et al (2012) convincingly demonstrate that having negative equity is a necessary condition to strategically default on one's mortgage. Moreover, the greater the amount by which the homeowner is underwater, the greater the incentive (and likelihood) to default.…”

“…4 The way in which the foreclosure process is being handled is constantly evolving across the country so much so that attorneys who specialize in helping homeowners navigate the process are often unsure of how to coach their clients through the maze of legal uncertainty. 5 Seiler et al (2012) document that additional disadvantages to defaulting include a reduced credit score making future credit both more difficult and more expensive to obtain, potential moving costs (if the home is a primary residence), uncertainly surrounding the tax treatment of waived deficiency judgments, and the social stigma of friends and family learning that the homeowner defaulted on a loan. substrates associated with feelings of cognitive dissonance.…”

“…The current consensus is that a substantial amount of negative equity is necessary to trigger the decision (Bhutta, Dokko, and Shan, 2010). Guiso, Sapienza, and Zingales (2013) and Seiler et al (2012) go beyond the economic triggers of default and examine the behavioral considerations. The purpose of the current investigation is to go even deeper and understand both the economic and behavioral motivations for strategic mortgage default at a neurological level.…”

The role of informational uncertainty in the decision to strategically default

“…Alternatively, when monetary rewards and penalties resulting from a breach of contract are stated in definitive terms, these explicit rules ''crowd out'' implicit social norms that would otherwise dictate behavior (Gneezy and Rustichini, 2000). Guiso et al (2013), Seiler et al (2012) and White (2010) find that society currently views strategic mortgage default as morally objectionable. As a result, if mortgage contracts remain relatively silent on the ramifications of breach, it is reasonable to believe this social norm (not to default) will reign and strategic defaults will be rare.…”

Strategic, unaffordability and dual-trigger default in the Irish mortgage market

“…Burke and Mihaly (2012), also based on survey data, find that social perceptions about the acceptability of strategic default, and financial literacy (the ability to navigate the US bankruptcy system) influence household's tendency toward strategic default. Seiler et al (2012) report that networks are an important determinant of strategic default: borrowers who have family and friends in default are more likely to strategically default themselves. Towe and Lawley (2010) also find that social interactions play a significant role in the decision to default, in that having a neighbor in foreclosure increases the probability of default by 28%.…”