Kyle F. Herkenhoff

Unemployment, negative equity, and strategic default

Using new household level data, we quantitatively assess the roles that (i) job loss, (ii) negative equity, and (iii) wealth (including unsecured debt, liquid, and illiquid assets) play in default decisions. In sharp contrast to prior studies that proxy for individual unemployment status using regional unemployment rates, we find that individual unemployment is the strongest predictor of default. We find that individual unemployment increases the probability of default by 5-13 percentage points, ceteris paribus, compared to the sample average default rate of 3.9%. We also find that only 13.9% of defaulters have both negative equity and enough liquid or illiquid assets to make 1 month’s mortgage payment. This suggests that “ruthless,” or “strategic” default during the 2007-2009 recession is relatively rare, and suggests that policies designed to promote employment, such as payroll tax cuts, are most likely to stem defaults in the long run rather than policies that temporarily modify mortgages.

How Credit Constraints Impact Job Finding Rates, Sorting & Aggregate Output

We empirically and theoretically examine how consumer credit access affects displaced workers. Empirically, we link administrative employment histories to credit reports. We show that an increase in credit limits worth 10% of prior annual earnings allows individuals to take .15 to 3 weeks longer to find a job. Conditional on finding a job, they earn more and work at more productive firms. We develop a labor sorting model with credit to provide structural estimates of the impact of credit on employment outcomes, which we find are similar to our empirical estimates. We use the model to understand the impact of consumer credit on the macroeconomy. We find that if credit limits tighten during a downturn, employment recovers quicker, but output and productivity remain depressed. This is because when limits tighten, low-asset, low-productivity job losers cannot self-insure. Therefore, they search less thoroughly and take more accessible jobs at less productive firms.

What Actually Causes Mortgage Defaults, Redefaults, and Modifications

I use new household level data to simultaneously test three competing hypothesis about the primary cause of mortgage default. I consider the potential interactions of individual unemployment spells, negative equity, and unsecured debt. Unlike past studies that were only able to control for regional unemployment rates, I find that the double trigger event of job loss and negative equity is crucial in determining default as has been widely hypothesized in the literature. In every specification considered, the interaction term between unemployment and negative equity is significant indicating that double trigger events are the culprit in generating persistent defaults as hypothesized by Foote, Gerardi, and Willen (2009). I find that a person who has negative equity and who is unemployed is 10% more likely to default than a person who has just negative equity. The negative equity alone only makes a person 1.45% more likely to default, a factor of 6 smaller than the interaction probability. Unsecured debt plays a tertiary role compared to negative equity and unemployment, and past modifications make someone 20% more likely to have defaulted at the survey date. Redefaults, which are defaults after modification, are also well predicted by an interaction between unemployment and negative equity, and modifications are best predicted by past negative equity which makes someone 8% more likely to receive a modification.