Today, the matter is far from theoretical for the 15.2 million American households holding mortgages that exceed the value of their homes. It will help determine how many of them choose to “default strategically”””that is, walk away from their mortgages even when they can afford them, because they’ve determined that it’s no longer worth it to keep paying. And that, in turn, will help determine the future health of the American housing market””and thus of the U.S. economy.
Many people think that we don’t have to worry about widespread strategic defaults. When I discussed the problem with a board member of one of the top four American banks, he categorically denied its existence: “The idea that people would walk away from their homes when they can still afford to pay the mortgage is unfounded.” A study from the Federal Reserve of Boston seems to confirm his skepticism. Evaluating Massachusetts homeowners during the 1990”“91 recession, it found that only 6.4 percent of “underwater” borrowers””that is, those burdened with mortgages that exceeded the value of their homes””ended up in foreclosure. And not all of those households were defaulting strategically; many, presumably, were actually unable to pay their mortgages.
Unfortunately, such evidence may not tell us much about the likelihood of strategic default today. During the 1990”“91 recession in Massachusetts, home prices fell just 22.7 percent from peak to trough, and most borrowers had made 20 percent down payments””so few owed much more than their houses were worth. Even people who had bought at the peak owed, on average, just 3 percent more than the value of the house. Over the last few years, by contrast, home prices have fallen by 40 to 50 percent in several areas, and many borrowers had put very little or nothing down when they bought their houses….