When Banks Can't Go After Defaulters

by Zubin Jelveh | July 13, 2009

In the comments to my first post on walk-aways, some wondered what effect non-recourse loans have on the incentives for homeowners to keep paying their mortgages even if they're underwater. That is, if the bank can't go after you when you default, it would certainly seem to increase the chances that you'd walk away from your mortgage.

It turns out that this is very true, according to a new paper from the Richmond Fed by Andra Ghent and Marianna Kudlyak. Comparing defaults in states with and without recourse laws, the researchers find that, on average, someone with negative equity is 20% more likely to default in a non-recourse state. Here's the breakdown:

The effect is significant only when the borrower is likely to have significant assets or income...For borrowers with properties appraised at less than $200,000, there is no difference in the probability of default across recourse and non-recourse states...for homes appraised at $300,000 to $500,000, borrowers in non-recourse states are 59% more likely to default...For homes appraised at $500,000 to $750,000, borrowers in non-recourse statess are almost twice as likely to default as borrowers in recourse states while for homes appraised at $750,000 to $1 million, borrowers in non-recourse states are 66% more likely to default as borrowers in recourse states.

Ghent and Kudlyak also make the important point that the much-cited Boston Fed study which looked at foreclosure rates for those with negative equity in the early 1990's (and found them to be quite small) isn't representative of the entire country since Massachusetts is a recourse state.

The following chart I whipped up shows the percent change in foreclosure filings between 2006 -- when the housing bubble peaked -- and 2008 in non-recourse vs. recourse states using data from RealtyTrac:


Does this mean that walk-aways are a bigger problem than I originally argued? Not really -- largely because recourse states greatly outnumber non-recourse states. Ghent and Kudlyak analyzed the foreclosure laws for all 50 states and categorized 11 as non-recourse. The states -- Alaska, Arizona, Calfornia, Iowa, Minnesota, Montana, North Carolina, North Dakota, Oregon, Washington, and Wisconsin -- account for 25% of the nation's housing stock with California making up 49% of that. Also, seven of these states have foreclosure rates that are less than the national average.

Still, there are reasons for concern.

The association between price declines and foreclosures is much stronger in non-recourse states than in recourse ones. (I ran a simple regression to establish this.) At the same time, unemployment rates have increased by about the same amount in both recourse and non-recourse states. This further backs up Ghent and Kudlyak's finding that negative equity, rather than lack of funds, plays a substantial role in foreclosure decisions in non-recourse states.

So, while I don't think walk-aways are a national phenomenon that should be of primary concern when it comes to fixing the housing markets, states like Arizona and California, which have seen huge spikes in foreclosures, should think about changing recourse laws as soon as they can. 

--Zubin Jelveh

Source URL: http://www.newrepublic.com//blog/the-stash/when-banks-cant-go-after-defaulters