Written by Kyle Herkenhoff, 4th year in the UCLA Economics PhD program
Imagine you took out a mortgage with monthly payments of 1200. Unfortunately, you lost your job, and now receive 1600 per months in benefits. If you have no other payments, that leaves you with 400 dollars to cover food, other debt bills, etc. What is the best way to maintain your standard of living? Simply skip several payments, i.e. become delinquent in mortgage jargon, and when you get a job again, catch up on the payments. How many payments can you miss before the bank comes knocking on your door? This length of time from the first instance someone skips a mortgage payment unitl final eviction is now up to 2 years in some regions of the United States.
If you decide to skip payments to maintain your standard of living, this is what economists would call a classic case of consumption smoothing. Throughout most of the 2000s, this consumption smoothing mechanism did not exist. The banks were relatively quick to foreclosure, and people were less likely to exhibit the behavior described above; delinquency stocks were low and delinquency episodes were shorter.
In the most recent recession, the data show that there is an abnomorally large group of people who skip their payments for a protracted period of time (1 year or more), and eventually resume payments to keep their house. There is an equally large group of people that skip their payments for 2 years and lose their house as a result.
Recently, Lee Ohanian and I have successfully generated this type of behavior in what economists call a dynamic stochastic partial equilibrium model (this is just a long name for a tool that is used to analyze decision behavior). We find that the option to skip payments for long periods of time dramatically changes peoples’ incentives to go out and look for jobs and has broader implications for the overall unemployment rate. As people get closer to the eviction date, they look much harder and accept lower paying jobs in the hopes of saving their home.
I will talk about the policy and welfare implications of this observation in a later blog post. I will simply leave you with the million dollar question: how does an economist compare the value of a job versus the social costs or benefits of delinquency?