Adversity or Strategy?: The Effects of Credit Constraint and Expectation on Mortgage Default and Personal Bankruptcy Decisions

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1 Adversiy or Sraegy?: The Effecs of Credi Consrain and Expecaion on Morgage Defaul and Personal Bankrupcy Decisions A hesis submied by Yoshiyuki Miyoshi In parial fulfillmen of he requiremens for he degree of Maser of Ars in Economics TUFTS UNIVERSITY May 2008 Advisor: Yannis Ioannides

2 Absrac This hesis conribues o he lieraure on morgage defaul and personal bankrupcy wih empirical findings, which disenangle he wo mainsream heories: he willingness-o-pay heory and he abiliy-o-pay heory. The emphasis is on credi consrains and insolvency in order o inegrae hese wo heories. The esimaion resuls of a model of simulaneous choices beween morgage and nonmorgage delinquency sugges ha credi consrains and borrowers insolvency are he bridge beween he wo conflicing heories. I also find he imporance of backward-looking expecaions and he homesead exempion in households decisions on morgage defaul and bankrupcy. In addiion, wih a model of bankrupcy decisions, I show ha credi consrained and seriously financially disressed households ac more ruhlessly based on heir financial benefi from bankrupcy filings. i

3 Acknowledgmen I would like o express my sinceres graiude o my advisor, Professor Yannis Ioannides, whose paience, enhusiasm, experise, and guidance, have added considerably o my research experience. Beginning wih a class of graduae macroeconomics under his direcion, in which I wroe a research paper in economics for he firs ime in my life, he has helped me make significan academic progress in organizing and developing my ideas and houghs. He was also he one who inspired me o work on morgage defaul and personal bankrupcy, which I never knew ha was such an exciing subjec as i is. Wihou his encouragemen and suppor, I would no have been able o wrie his hesis. I would like o hank Professor Gilber Mecalf for all his guidance. While working as a research assisan for him, I learned wha professional economic research is like. I would also like o hank Professor Jeffrey Zabel and Professor Edward Kusoai for heir insighful commens during he defense. I would also like o show my appreciaion o Professor Joshua Fischman for his suppor for his projec. I am also graeful for he guidance of my academic advisor, Professor Marcelo Bianconi, in he pursui of he maser s program in economics a Tufs. I am grealy indebed o he Minisry of Land, Infrasrucure, Transpor and Tourism of he Japanese governmen for is financial help. Finally, I would like o hank my parens, my broher and my friends for all of heir emoional suppor in he compleion of his hesis. ii

4 Table of Conens Absrac Acknowledgmen i ii Inroducion Chaper : Morgage defaul, delinquency and personal bankrupcy 3. Inroducion 3.2 Definiion 4.3 Lieraure review 7.4 Deerminans of borrowers decisions of defaul, delinquency and bankrupcy 0.4. Dependen and explanaory variables in he SCF Probi esimaions for delinquency, defaul and bankrupcy Ordered probi specificaion for delinquency and defaul Srucural change of he impac of ARMs 20.5 Conclusion 22 Chaper 2: Delinquency choice beween morgage and nonmorgage loans Inroducion Theoreical framework Delinquency, defaul and bankrupcy, revisied Theoreical consideraion I: financial profis Theoreical consideraion II: credi consrain Esimaion mehodology and variables Specificaion of muliple choice esimaion 43 iii

5 2.3.2 Daa and variables Empirical resuls and some exensions Resul of he base specificaion Proecing housing invesmens hrough bankrupcy Households aiude oward risks Conclusion 56 Chaper 3: Personal bankrupcy decisions of morgage borrowers Inroducion Theoreical model for financial benefi from bankrupcy Daa and esimaion mehodology Recen bankrupcy experiences of he households in he SCF Homesead exempion as a random variable Esimaion mehodology for binary choice Piecewise specificaion for homesead exempion Explanaory variables Esimaion resuls Bankrupcy decisions of morgage borrowers in dead-end delinquency Adjusmen for dead-end delinquen households Esimaion resuls for dead-end delinquen households Conclusion 8 References 96 iv

6 Inroducion This hesis examines households decisions on morgage defaul, personal bankrupcy and loan delinquency from several viewpoins by using a household-level daase from he Survey of Consumer Finances (SCF). One of he main objecives of his hesis is o conribue o he lieraure on morgage defaul and personal bankrupcy by disenangling he wo mainsream heories: he willingness-o-pay heory and he abiliy-o-pay heory. The emphasis is on credi consrains and insolvency in order o inegrae hese wo heories. Alhough morgage defaul and personal bankrupcy are wo major devices ha financially disressed homeowners can choose, here are no empirical sudies ha direcly address hese simulaneous and muliple choices beween morgage defaul and personal bankrupcy. The empirical resuls repored in his hesis sugges ha some of he deerminans work in compleely differen ways for borrowers decisions on morgage defaul and filing for bankrupcy respecively. Paricularly, he effecs of he amoun of paymens for differen ypes of loans srongly suppor he validiy of he hypohesis ha credi consrains and borrowers insolvency are he bridge beween he wo conflicing heories. I also focus on borrowers backward-looking expecaions of capial gains, which has araced lile aenion in he previous sudies of morgage defaul and, as long as I know, no aenion a all in he lieraure on households bankrupcy decisions. The empirical resuls in his hesis show ha backward-looking expecaions of capial gains play an imporan role in households decisions on loan paymens, in paricular ineracing wih a remarkable feaure of he U.S. bankrupcy law: namely, he homesead exempion. Chaper reviews he conceps, he erminology, he legal frameworks, and he lieraure ha are relevan o he sudy of morgage defaul, personal bankrupcy and loan delinquency.

7 Then, hrough he probi esimaion by using he SCF, I confirm he findings of previous sudies; boh he willingness-o-pay heory and he abiliy-o-pay heory have predicive power for morgage defaul, bankrupcy and loan delinquency. I also find an emerging imporance of adjusable rae morgages for morgage defaul in he U.S. Chaper 2 formulaes a mulinomial choice model beween morgage and nonmorgage loan delinquency, based on an idea ha hese delinquency decisions are closely relaed o borrowers decisions beween morgage defaul and bankrupcy. Wih a model aking accoun of credi consrained households as well as households ha jus ry o obain financial profis from morgage defaul or bankrupcy, he empirical resuls sugges ha households decisions are firsly based on financial profis, bu he combinaion of credi consrains and insolvency drives some households ino morgage defaul or bankrupcy agains heir will. I also find ha backward-looking expecaions of capial gains are playing an imporan roll along wih he homesead exempion. In addiion, I idenify he impac of households heerogeneiy owards financial risks, which some previous sudies find indirecly, by explicily using a parameer of households preferences. Chaper 3 concenraes on households bankrupcy decisions, emphasizing he effecs of backward-looking expecaions and he homesead exempion. In addiion o he empirical suppor for a general case, he resuls in his chaper also reveal ha credi consrained and seriously financially disressed households ac more ruhlessly based on heir financial benefi from bankrupcy filings. These findings give furher grounds for he imporance of credi consrains in reconciling he wo heories; once households are caugh by hopelessly severe financial disress due o a lack of abiliy o pay, hey choose heir acions among available alernaives primarily based on he financial benefi ha hey would be able o obain. 2

8 Chaper : Morgage defaul, delinquency and personal bankrupcy.. Inroducion The housing finance marke in he Unied Saes has experienced considerable srucural change in recen years. The percenage of Americans who own homes is 68.4 in 2007, having shown a sudden increase by more han four poins during he las decade afer years of being relaively consan a near 64 percen. According o he SCF, a comprehensive survey on households financial circumsances conduced by he Federal Reserve, among households ha have morgage loans, he median amoun of deb secured by residenial properies increased by 47% in only 6 years, from 68,000 in 998 o 00,000 in The share of households ha ook ou home equiy loans agains heir residenial properies as collaeral, which is ofen viewed as one of he major problem causes in he recen downurn in he housing finance marke 3, increased by 20.6% during he same period. Afer his expansion of he housing finance marke, he recen siuaion which home morgage debors are facing during downurn in housing markes is drawing close aenion by people in a variey of social quarers, such as business, finance, governmen and even inernaional insiuional agens 4. The main concern of hese people is how much morgage loans are in rouble and why; since he secondary morgage marke has developed so well ha many loans are bundled ino morgage-backed securiies and raded on a world-wide marke, all he Housing Vacancy Survey, U.S. Census Bureau. (hp://www.census.gov/hhes/www/housing/hvs/annual07/ann075.hml) 2 Auhor s calculaion. 3 Home Economics, he New Yorker, March 0, (hp://www.newyorker.com/alk/financial/2008/03/0/08030a_alk_surowiecki) 4 For example, he Japanese governmen esimaed he oal value of he asses backed by subprime morgages ha Japanese financial insiuions hold in February, (hp://www.fsa.go.jp/news/9/ginkou/ /0.pdf) 3

9 people across he globe involved in financial aciviies are anxious abou wha would happen if a large fracion of he curren morgage balance could no be repaid 5. Considering his imporance of residenial morgage loans o he enire financial sysem of he Unied Saes, and as i appears of he inernaional finance world as well, he focus in his paper is on he behavior of financially disressed households who have morgage debs. There are several opions for borrowers who canno coninue o repay heir morgage debs. Morgage defaul and personal bankrupcy, if hey have oher unsecured loans, are such primary examples. Also hey migh be able o recover normal financial saus jus by selling heir homes in he marke. However, recen research in financial economics has revealed ha borrowers, even including borrowers who are no facing serious paymen problems, may exer opions of morgage defaul and file for personal bankrupcy sraegically. These financial devices were originally inended, however, o help borrowers who suffer from severe financial disress. In paricular, he consensus ha he legal sysem regarding bankrupcy favored debors and ha some borrowers may have abused he sysem encouraged he U.S. Congress o amend he bankrupcy law in 2005 in order o ighen he requiremens for bankrupcy. This paper will invesigae, using he SCF, evidence of borrowers sraegic behavior and deerminans affecing heir decisions..2. Definiions I would like o sar wih clarifying he definiions of he key conceps and associaed erms used in his paper. When a borrower misses any of her loan paymens, we say ha she is in delinquency. On he oher hand, alhough morgage defaul also refers o failures of borrowers o 5 Could Risky Morgage Lending Pracices Prick he Housing Bubble?, Sepember 2, (hp://knowledge.wharon.upenn.edu/aricle.cfm?aricleid=280) 4

10 honor he erms of heir loan agreemens in general, here is no formal universally acceped definiion of wha consiues morgage defaul (U.S. Deparmen of Housing and Urban Developmen 2007). This definiion is so vague ha some people may inerpre skipping a single paymen as defaul, which we define as delinquency above. Ohers also may define defaul as compleion of foreclosing on, or acquisiion of morgaged properies by lenders 6. This difference in he definiion of morgage defaul is unavoidable because usually here is a lapse of several monhs beween sar of missing paymens and foreclosure (or oher pos-delinquency oucomes). Since legal proceedings of foreclosure are cosly o lenders and delinquen morgages are ofen collaeralized by properies whose value fell below he loan balance, lenders are willing o work wih nonpaying borrowers and renegoiae loan erms as long as i is less cosly o hem han resoring o foreclosure. Therefore, he number of periods afer which foreclosure does ake place depends on lenders decisions. Three monhs of delinquency is he prevailing sandard o judge he probabiliy of foreclosure in pracice (Quercia and Segman 992). Tha is why hree monh of delinquency is someimes ermed serious delinquency (e.g. Ong, Sing and Teo 2007). Bankrupcy, or personal bankrupcy o be exac, is more sraighforward o define, compared o morgage defaul, since i is riggered by a deliberae acion of borrowers, bankrupcy peiions. In he Unied Saes bankrupcy law, here are wo chapers providing opions for personal bankrupcy: Chaper 7 and 3 7. Alhough he legal reamen of bankrupcy underwen significan changes by he amendmen in 2005 as menioned above, he analysis in his paper is based enirely on he bankrupcy law before he 2005 changes, because he daase ha I use originaes in 2004 a he laes. 6 Ambrose and Capone (996) show ha since foreclosure is he mos cosly pos-delinquency oucome from lenders perspecive, lenders prefer less cosly oucomes, such as a deed-in-lieu-of-foreclosure or preforeclosure sale. 7 Morgage borrowers can also file for Chaper bankrupcy if hey are business owners. 5

11 Chaper 7, or sraigh bankrupcy, is inended o offer borrowers a fresh sar by discharging mos unsecured debs and liquidaing heir nonexemp asses. However, secured loans (including morgage loans), suden loans, child suppor obligaions, and deb incurred by fraud canno be discharged according o Chaper 7. On he oher hand, crediors are no qualified o liquidae any asses of debors, bu crediors are eniled o claim all of debors asses above fixed levels of bankrupcy exempions. An inerim rusee, who is appoined by he cour when bankrupcy is filed for, oversees he liquidaion of nonexemp asses and disribues he proceeds o repay crediors. Alhough bankrupcy operaes under federal law, saes have he righ o se heir own bankrupcy exempions. Mos saes have adoped differen levels of exempions for borrowers home equiy, which is called homesead exempion, along wih bankrupcy exempions for a variey of oher ypes of asses 8. While borrowers do no have o pay anyhing from properies whose values are less han corresponding exempion levels, morgage lenders have a prioriy on liquidaion of morgaged properies. Thus he rusee does no allow crediors o liquidae morgaged properies if here would be no proceedings lef beyond he sum of homesead exempion and morgage balance. In his case, if debors who are no behind in heir morgage paymens wish o reain heir properies, hey can do so by reaffirming he morgage debs. Chaper 3, which is also known as a wage earner proceeding 9, requires borrowers o propose a plan o repay par of heir debs from fuure earnings, usually over hree o five years, insead of discharging unsecured debs immediaely. Even hough Chaper 3 discharges some ypes of debs which are no discharged under Chaper 7, liabiliies incurred by fraud, for insance, 8 Whie (998) presens a sae-by-sae lis of bankrupcy exempions. 9 Brueggeman and Fisher (2005). 6

12 more han 70% of personal bankrupcy filings occur under Chaper 7 0. Whie (2007a) argues ha his populariy of Chaper 7 should be aribued o a couple of reasons; borrowers are no obliged o repay from heir fuure earnings under Chaper 7. Moreover, hey can even proec heir wealh by convering i from a nonexemp form o an exemp form before filing for Chaper 7. While he descripions above have shown morgage defaul and personal bankrupcy are differen in heir procedures o some exen, he number of people who use hese devices is seadily increasing. Alhough I do no have access o daa on he raes of morgage foreclosures, LaCour-Lile (2004) shows ha he raes of foreclosure on governmen-insured loans have ripled during he period beween 986 and 2002, while he raes of bankrupcy per capia have also ripled during he same period 2. Thus he long-erm rends of morgage defaul and personal bankrupcy filings are similar o one anoher and increasing a he same pace..3. Lieraure review There is a rich lieraure boh on morgage defaul and on personal bankrupcy. The empirical sudy of personal bankrupcy seems slighly lagging behind ha of morgage defaul due o daa availabiliy. Indeed, he developmen of he lieraure in hese wo fields is quie similar o one anoher 3. In boh fields, here are wo sreams, he willingness-o-pay heory and he abiliy-o-pay heory 4, and hese wo ypes of heories coexis being suppored by empirical sudies. Morgage defaul can be viewed as a financial opion ha gives borrowers he righ o 0 Bankrupcy Saisics in 2004, U.S. Cours. (hp://www.uscours.gov/bnkrpcysas/bankrupcysas.hm) Bahchieva, Wacher and Warren (2005) poin ou his possibiliy indicaing ha he loan-o-value raio of morgage borrowers who filed for bankrupcy is subsanially increasing recenly. 2 Auhor s calculaion based on Bankrupcy Saisics, U.S. Cours, and Populaion Esimaes, U.S. Census Bureau. (hp://www.census.gov/popes/esimaes.php). 3 Lin and Whie (200, pp.40) poin ou his fac. 4 This erminology follows U.S. Deparmen of Housing and Urban Developmen (2007). 7

13 sell he morgaged properies o he lenders in exchange for release of heir deb conracs. A sraighforward inerpreaion ells us ha borrowers will defaul if heir home equiy is negaive, or in he money. On he conrary, hey will keep paying for heir morgages if he home equiy is posiive, or ou of he money. This simple formulaion may well describe borrowers willingness o pay off heir morgage. One of he seminal works in he morgage defaul area is Foser and Van Order (984), who formally inerpre morgage defaul as exercising a pu opion and apply opion heory o heir empirical sudy. Their empirical work shows he opion-based model of morgage defaul is so effecive ha i explains over 90 percen of he variance jus by he home equiy variables. On he oher hand, hey also find he defaul opion is no exercised immediaely, since lagged variables for households equiy posiions have saisically and economically significan effecs. This resul suggess ha he simple opion-based heory canno explain borrowers behavior perfecly. Deng, Quigley and Van Order (2000) remedy his deficiency by inroducing anoher opion, prepaymen of morgage, for which a call opion model seems appropriae. While he simulaneous opion model of Deng, Quigley and Van Order (2000) works well, heir conribuions are no limied o he inroducion of he prepaymen opion. Their empirical resuls also suppor he heory of borrowers abiliy o pay. Since morgage loans require a sringen commimen by borrowers, in oher words, heir making regular paymens, ypically every monh, researchers in he field of morgage defaul have been paying aenion o he affordabiliy of morgage paymens, or borrowers abiliy o pay. While his abiliy is basically measured by he household s income and he amoun of morgage paymen, his heory also pus much emphasis on unexpeced evens, ofen called rigger evens, ha shock borrowers abiliy o pay, such as unemploymen and divorce. These wo evens, unemploymen and divorce, are 8

14 exacly wha Deng, Quigley and Van Order (2000) find o have significan effecs in heir model. The oher previous sudies uncover he significan facors of his ype. For insance, Vandell and Thibodeau (985) he defaul risk of self-employed borrowers are higher probably due o heir income volailiy. I is imporan o noe ha he credi consrain will be a fundamenal background o he abiliy-o-pay heory from he perspecive of he consumer choice heory. There will be a case in which, even hough borrowers hope o keep heir homes expecing financial profis, hey have o defaul because hey run ou of cash flow for regular paymens and canno borrow addiional money o handle emporary financial adversiies. In addiion o unemploymen and divorce, Elul (2006) argues ha he explanaory power of original morgage loan-o-value raio found in he empirical sudy of Deng Quigley and Van Order (2000) provides evidence for he exisence of credi consrains, since borrowers who have less wealh available for down paymens are more likely o be credi consrained. Elmer and Seelig (999) argue ha he opion-based willingness-o-pay heory has is limiaions in describing borrowers behavior abou morgage defaul, and ha morgage defaul should be analyzed wih a choice-heoreic framework ha inegraes he willingness-o-pay heory and he abiliy-o-pay heory. The siuaion is similar in he field of personal bankrupcy sudies. Sullivan, Warren and Wesbrook (989) propose an abiliy-o-pay heory, namely ha borrowers file for bankrupcy only when an unanicipaed even occurs ha reduces heir abiliy o mee heir loan paymens. On he conrary, Whie (998) and Fay, Hurs and Whie (2002) inroduce a willingness-o-pay heory by esablishing he framework o measure borrowers financial benefi from bankrupcy filings ha incorporaes heir unsecured debs, nonexemp asses, bankrupcy exempions and he coss of filing for bankrupcy, such as legal fees and limied access o credi in he fuure. The 9

15 empirical work of Fay, Hurs and Whie (2002) shows ha he financial benefi from bankrupcy filings has significan impac on borrowers decisions on bankrupcy. However, hey also find a household s income, which is closely relaed o he abiliy-o-pay heory, affecs decisions. Fisher (2005) reaffirms he empirical evidence for he effec of household s income even wih his more deailed specificaion. To summarize, in boh fields of he sudy of morgage defaul and personal bankrupcy, he willingness-o-pay heory is clearly well-defined, bu leaves no room for nonfinancial facors o affec hese decisions from a purely heoreical viewpoin. This heory is given pleny of srong empirical suppor. Noneheless, he empirical works also sugges he validiy of rigger evens as well as financial variables, supporing he abiliy-o-pay heory. The credi consrain is one of he mos promising candidaes for reconciliaion beween hose seemingly conflicing heories. Thus one of main objecs of his hesis is o invesigae how credi consrain funcions for morgage defaul and personal bankrupcy..4. Deerminans of borrowers decisions of defaul, delinquency and bankrupcy.4.. Dependen and explanaory variables in he SCF In he res of his chaper, I will provide an overview of deerminans of he probabiliy of delinquency, defaul and bankrupcy filing by reduced-form models using a daase from SCF in 998, 200 and The following wo chapers also use daases from he SCF. Alhough he SCF has some disadvanages, paricularly compared o panel daases, such as he Panel Sudy of Income Dynamics (PSID) 5, he SCF has such significan advanages ha make i he bes choice o use he SCF daases in his hesis. Firs of all, he SCF surveys households paymen 5 I will discuss he disadvanages of he SCF and he measures ha we can ake in order o reduce he disadvanages in more deail in he following wo chapers. 0

16 performance for each deailed caegory of debs as well as he amoun of paymens and curren balance for hose loan caegories. In paricular, hese variables allow us o derive implicaions for borrowers simulaneous choices beween morgage defaul and bankrupcy, which is discussed in Chaper 2 in more deail. Second, since one of he main objecives of his hesis is he behavior of credi consrained households, informaion abou credi consrains is crucial. In his regard, he quesions abou households loan applicaions and is denials ha he SCF asks are very useful. The SCF also has anoher unique variable relevan o my sudy, which is abou households aiude owards financial risks and profis. Lasly, he SCF conains very deailed informaion on he characerisics of each household s residenial morgage, including wheher i is subjec o adjusable raes or no. Table - summarizes he variables regarding delinquency, defaul and bankrupcy ha he SCF invesigaes. As for loan delinquency, he SCF asks he households if hey are paying each ype of loans, such as morgage loans, car loans and consumer loans, as scheduled. I also inquires as o heir loan paymen hisory in general in he previous year. Tha is, wheher hey missed any loan paymens a leas once during he previous year, which is followed by an addiional quesion wheher hey did so for hree monhs or more. The laer is ermed serious delinquency. The SCF sared asking abou personal bankrupcy experiences since is 998 survey. Specifically, i asks wheher he households have ever filed for bankrupcy and, if hey had, when he mos recen filings were. Table -2 repors he frequencies for households ha are in delinquency or filed for bankrupcy in he SCF of 998, 200 and Since he plan of his hesis is o analyze behavior of households who have morgage debs, he raes in Table -2 are abou he morgage-indebed households only. All of he hree variables regarding delinquency show he

17 same paern: hey peaked in 2004 afer dropping once in 200. This rend agrees wih he daa published by U.S. Deparmen of Housing and Urban Developmen (2007) and discussed by LaCour-Lile (2004). The movemen of he raes of bankrupcy filings does no follow precisely he rend in he Unied Saes during ha period shown in Figure -. This migh be aribued o he fac ha he daa in Figure - are based on he enire populaion in he Unied Saes. My daase from he SCF only includes he homeowners wih morgage debs; he bankrupcy filing rend of he morgage debors may be differen from he naionwide rend. Previous sudies have found a variey of facors affecing households decisions on defaul and bankrupcy, as discussed in he lieraure review. The relevan variables used in his hesis are summarized in Table -3. From he viewpoin of he heory of borrowers abiliy o repay, household s income and he amoun of morgage paymen should have imporan effecs on borrowers decisions on defaul and bankrupcy, along wih rigger evens such as losing jobs and an unexpeced decrease in income. Credi consrains will also be criical since credi consrained households could no miigae such unexpeced adversiies by aking on addiional loans. On he oher hand, he heory of borrower s willingness o repay emphasizes ha he main deerminans should be borrowers equiy posiion in morgaged propery, which is measured by he variables such as loan-o-value raio (LTV). To es he impac of hese facors on borrowers decisions on defaul and bankrupcy filings, I perform several esimaion for delinquency, serious delinquency and bankrupcy respecively, wih he explanaory variables conained in he SCF, as described in Table -4. I include several variables ha are no discussed above. For example, he non-labor income raio may provide a cushion agains unexpeced shocks o wage income. Thus he effec will be negaive on he probabiliy of delinquency and bankrupcy. 2

18 I ake advanage of he deailed informaion abou he characerisics of morgage loans ha he SCF provide by including dummy variables for adjusable rae morgages (ARMs), morgage refinancing and home equiy loans in he esimaions o follow. Since ARMs change heir ineres raes according o he presen economic siuaions, usually conneced o he ineres raes of oher financial asses, hey may cause shocks o borrowers abiliy o pay by increasing he ineres raes. In addiion o reducing borrowers home equiy, home equiy loans can be exploied o ake more advanageous resuls ou of bankrupcy filing. Tha is, borrowers can proec heir home from liquidaion by reducing heir home equiy below he level of homesead exempion. While ARM and home equiy loans are ofen blamed for he recen jump in he raes of morgage defaul, households who could manage o refinance heir morgages are more likely o be able o avoid giving up heir homes. I will also look a he effecs of he variables regarding household-level economic characerisics. In paricular, Vandell and Thibodeau (985) find self-employed households are more likely o defaul due o heir volailiy in income. The SCF enables us o es his effec. Because a variey of ypes of morgage producs are rapidly being developed and he originaion of nonradiional morgages accouns for a subsanial fracion of he U.S. morgage marke (Edmison and Zalneraiis, 2007), professional financial counseling became more imporan for borrowers, mos of whom are no professionals in finance. I expec financial counseling will have some effec in prevening borrowers from financial disress, in oher words, defaul or bankrupcy. Moreover, wo disincive variables of he SCF are used in he analysis: ha is, dummy variables for credi consrains and households aiude owards financial risks. The former is generaed based on he quesions in he SCF abou resuls or expecaions of households loan 3

19 applicaions. On he oher hand, households aiude owards risks is measured by a hypoheical quesion abou financial opporuniies. Since boh variables play a key role in he argumen in Chaper 2, I will give more deail, including precise descripion of relevan quesions in he SCF, in ha chaper. Lasly, I include a se of demographic variables regarding sex, age, race, marial saus, family member and educaion. Among hem, we may well expec marial saus and supporing children influence borrowers abiliy o pay; married couples will have flexibiliy in supplying working hours, while supporing children implies more inflexible spending due o mandaory expendiures, such as educaion expendiure Probi esimaions for delinquency, defaul and bankrupcy The explanaory variables discussed above are incorporaed ino a reduced-form model for he probabiliies of delinquency, serious delinquency (delinquency for hree monhs or more), morgage delinquency and recen bankrupcy (bankrupcy filings wihin wo years) respecively, as follows: Pr ( y = ) = F( β x ), i=, K N x (.) i i i, where y i is a binary variable for he i-h household ha akes he value one, if he even corresponding o he regression, say delinquency, is rue, and zero oherwise. x i is he vecor of explanaory variables for he i-h household, which are lised in Table -4. β is he vecor of he parameers o be esimaed for each dependen variable. F () is an appropriae probabiliy funcion of he model. If we assume he probi funcion is applied o F (), Equaion (.) gives; Pr β x i ( y x ) = ( ) d, i=, K N = φ, i i, 4

20 where φ () denoes he probabiliy densiy funcion of he normal disribuion. Table -5 presens he resuls of he maximum likelihood esimaions of his probi specificaion for he probabiliy of delinquency, serious delinquency, morgage delinquency and recen bankrupcy, respecively. The firs hree columns, whose dependen variables are delinquency on any loans, serious delinquency and morgage delinquency, share he basic feaures. The variables relaed o borrowers abiliy o pay such as income, morgage paymen-o-income raio, unemploymen and unexpeced low income, have saisically significan coefficiens and, more imporanly, he magniude of he coefficien on credi consrain is he mos noable. Meanwhile, he variables corresponding o he oher heory, he willingness-o-pay heory, also have significan impac. The LTV has consisenly significan impac across all he hree columns. In addiion, for he probabiliy of morgage delinquency, original housing price has a negaive and saisically significan effec, while original morgage balance has a posiive effec, even hough he laer effec is marginally significan. This agrees wih he resul of Deng Quigley and Van Order (2000) ha shows original LTV is posiively relaed o morgage defaul risk, even afer conrolling for curren borrowers posiion in home equiy 6. The professional financial counseling has an effec in reducing he probabiliy of delinquency. As for morgage characerisics, adjusable rae morgages and holding home equiy loans increase he probabiliy of delinquency significanly. Refinancing morgages has a negaive effec on he probabiliy of delinquency, paricularly serious delinquency and morgage delinquency. Some of he 6 Alhough Elul (2006) inerpres he effec of original LTV as an evidence for he exisence of credi consrains in order o suppor he abiliy-o-pay heory, he resul here shows ha he effec of original LTV seems o persis even afer, a leas parially, conrolling credi consrains. This srongly suppors he argumen of Yezer, Phillips, and Tros (994); hey argue ha here is an asymmeric informaion problem beween morgage lenders and borrowers and ha risky borrowers are more likely o finance heir morgage wih higher LTV. 5

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