When Borrowers Choose Food Over Shelter

by Zubin Jelveh | September 23, 2009

In the comments to my latest post on strategic defaults, rhubarbs make some very solid points:

I'm sympathetic to your reading of this methodology. However, paying consumer-credit bills and not paying one's mortgage is a choice, and thus a strategic allocation of resources. The fact that this behavior is more prevalent in areas where housing values have dropped, and thus mortgages are more likely to be underwater, tends to reinforce the notion that this is a form of strategic default. Why have these people made this particular choice among which bills to pay? Precisely because of the incentives cited to explain the phenomenon of strategic default.

Now, if there were a way to quantify the anecdotally increasing number of people who keep current on credit card payments because that's the only way to buy groceries, that would be an interesting way into this data that might actually contradict the claims of strategic default. For those people, keeping current on consumer debt is not a sign of ability to pay mortgage and a choice to default; it is a sign of the choice to abandon shelter in favor of food, which is evidence of extreme economic distress, and just about the last "choice" anyone gets to make before becoming destitute.

The biggest obstacle in studying strategic default decisions is that it's very hard to get data on people's finances up to the point when the default happens. If we could clearly see that funds were available to pay the mortgage, then calling a default strategic--i.e. unneccesary--would be a lot easier.

Both the Experian-Wyman and academic studies I wrote about do the next best thing and try to judge people's financial hardship by looking at their credit payment histories on a broad range of liabilities. Experian's idea is that if all other bills are being paid, then a mortgage default should signal a default not related to a consumer being strapped for cash.

But, while this is a step toward identifying walk-aways, Experian's assumption may be too strong. The academic study I cited goes a few steps further and takes into account people's credit limits. It finds that people are more likely to keep up with their credit cards than their mortgages when their access to credit falls (that is, when they face financial hardship). Along these lines, another recent study found that consumers will turn to payday loans before tapping out much cheaper credit.

These results hints strongly that in the current economy, a number of consumers are choosing to maintain their access to credit cards rather than paying their mortgages because they depend on them them to pay for basic necessities. Interestingly, when home prices increase, we see the opposite thing happen: people are more likely to choose their mortgages over their credit cards -- which makes sense given that the likelihood of a bad economic outcome is lower in an economy with rising home prices:

The intuition is straightforward, during a time period of rising housing prices, when faced with a delinquency choice; individuals choose to defer payment on their credit cards rather than the increasing value asset...As liquidity increases, individuals default on their credit cards in place of their mortgage. When faced with lower liquidity, individuals appear to choose mortgage delinquency in order to protect the available remaining credit on their credit cards. Since credit cards are largely a cash substitute, this serves as a potential buffer against economic shocks.

So, are these decisions strategic? Certainly, but not in the coldly-calculating way that is often portrayed in stories about walk-aways. My sense is that the Experian results are picking up a number of consumers who are indeed facing financial hardship and whose defaults wouldn't qualify as strategic.

Source URL: http://www.newrepublic.com//blog/the-stash/choosing-food-over-shelter