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New Study by ODU's Seiler and Collins Examines Factors that Can Lead to Mortgage Default

The problem of homeowners walking away from mortgages they can afford to pay - known as strategic default - is a nationwide problem that threatens to cripple our economic recovery.

A new study led by Old Dominion University researcher Mike Seiler demonstrates that the advice of experts, or mavens, in the housing market has a significant effect on how the contagion of strategic default spreads.

Seiler, Robert M. Stanton Professor and Robert M. Stanton Endowed Chair of Real Estate in the College of Business and Public Administration, co-authored the study with Andy Collins, a research assistant professor at ODU's Virginia Modeling, Analysis and Simulation Center, and Nina Fefferman, an assistant professor at Rutgers University.

The study, funded by the Research Institute for Housing America (RIHA) of the Mortgage Bankers Association, is titled "Strategic Default in the Context of a Social Network: An Epidemiological Approach."

The study examines the factors that can lead to mortgage default, the role that influential members of our society play in people's decision to stop paying their mortgage and the impact on the broader housing market. The study was presented at the 2011 commonwealth of Virginia's Innovative Technology Symposium (COVITS) in Richmond on Sept. 26. It received the Governor's Technology Award for 2011 for Virginia in the category of "Cross-Boundary Collaboration in Modeling & Simulation."

"Recently, the overwhelming media coverage of the current financial crisis has made homeowners aware - or at least alerted them to become aware - of their equity position in their home," Seiler said. "While the merits of such a choice can and will continue to be debated, what is indisputable is that the possibility to strategically default has certainly been brought to the attention of current homeowners like never before, with potentially negative consequences for housing markets."

Key findings from the study include:

  • Strategic default is a result of a borrower's unwillingness to pay, even if able. It can be very difficult to determine whether a borrower is unable or unwilling to pay.
  • Ideas are transmitted through the population in ways similar to those in which diseases are transmitted. Thus, they can be modeled in a similar manner. Certain corrective factors may lead some borrowers to be resistant to the temptation to strategically default, including the ability of lenders to pursue deficiency judgments, provisions of the tax code and bankruptcy laws.
  • The model shows that real estate experts can influence market dynamics, but not in all cases. Markets are strong or weak due to fundamentals; however, markets in between can be pulled down or lifted up depending upon individual and expert behavior.

The study highlights those factors that distinguish an "economic default" (caused by hardship) from "strategic default" (selected as an option by homeowners who may be underwater on their mortgage), and the methods by which an idea such as "strategic default" can be transmitted through a population by contact with individuals and through social networks.

Through modeling and simulation, the authors demonstrate that defaults and foreclosures lead to lower home prices. And they say epidemic of strategic defaults can be initiated by advice from those who might be considered experts, which can lead to the collapse of a housing market

"Housing pundits share their expert opinion with a large audience on a frequent basis through the media. These social networks create the potential for much faster disease spread/cure than in the past," Seiler said.

"In fragile markets, advice by those considered to be experts can result in a flood of strategic defaults, causing a contagious downward spiral of home prices and potentially a market collapse."

He said a single strategic default does little to impact the price of nearby homes. However, Seiler said as more and more mortgages in the neighborhood go into default, their cumulative negative impact increases. "Much the same way as a disease spreads throughout a population, so, too, do decisions to 'strategically' default," Seiler said.

Seiler is director of the recently formed Institute for Behavioral and Experimental Real Estate (IBERE) at Old Dominion. IBERE researchers, who include collaborators in several other ODU colleges, will focus on identifying and measuring flaws or biases in people's decision-making processes around real estate issues, suggesting ways to correct them and help the market as a whole.

"We would love for IBERE to help find solutions to these problems in the real estate market, because they truly affect the whole economy. We're hopeful a different approach might yield new insight," Seiler said.

To access a copy of the strategic default social network report, visit the RIHA website at www.housingamerica.org. To see research currently being done by IBERE, go to www.ibere.org.


This article was posted on: November 18, 2011

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