Strategic Mortgage Defaulters Influenced by Social Persuasion

Unemployment and other economic difficulties have caused millions of homeowners to involuntarily default on their mortgages, but there are some borrowers who are induced to simply stop making their mortgage payments because their property value has fallen and they owe more than their home is worth.

According to a study commissioned by the Mortgage Bankers Association (MBA), oftentimes strategic defaulters are encouraged to walk away at the behest of so-called mavens, or prominent influencers within a borrower’s social network whose persuasive arguments convince the borrower that strategic default is the way to go.

The study, conducted by Michael J. Seiler of Old Dominion University; Andrew J. Collins of the Virginia Modeling, Analysis and Simulation Center; and Nina H. Fefferman of Rutgers University, examines the role that influential members of society play in people’s decision to stop paying their mortgage and the impact of strategic default on the broader housing market.

“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 commented. “[T]he possibility to strategically default has certainly been brought to the attention of current homeowners like never before, with potentially negative consequences for housing markets.”

Through simulation modeling, Seiler and his co-authors demonstrate that because defaults and foreclosures lead to lower home prices, an epidemic of strategic defaults initiated by advice from those who might be considered experts could potentially spell detriment for the already ailing housing market.

“As social animals, humans knowingly or otherwise look to their peers before reaching financially life-altering choices,” the authors write in the report outlining their findings.

Seiler stresses that ideas can easily be transmitted through the population. He notes that 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 spread [of strategic default] than in the past,” Seiler said, adding that those pundits with a far-reaching sounding board can greatly impact mortgage markets through behavioral advocacy.

“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,” according to Seiler.

The study notes that whether by choice or necessity, as foreclosures increase, they have an increasingly negative impact on the price of the healthy homes around them.

“One default does little to negatively impact the price of surrounding homes,” Seiler said. “However, as more and more mortgages in the neighborhood go into default, the negative impact is felt at an increasing rate. Much the same way as a disease spreads throughout a population, so, too, do decisions to ‘strategically’ default.”

Michael Fratantoni, MBA’s VP of research and economics, says research has clearly shown that a borrower’s inability to continue making mortgage payments is the most predictive of a mortgage default. However, it is much more difficult to predict or even detect a strategic default – a borrower who has the ability to pay, but simply stops in expectation of a financial gain, Fratantoni explained.

He says the consequences of strategic defaults can be destabilizing, particularly in markets that are already on the edge.

“From a policy standpoint, the research supports the contention that opinion and information (or disinformation) can move markets,” Fratantoni said. “More specifically, that policymakers and mavens have the ability to stabilize or de-stabilize markets.”

The study, entitled, “Strategic Default in the Context of a Social Network: An Epidemiological Approach,” received the Governor’s Technology Award for 2011 in Virginia in the category of “Cross-Boundary Collaboration in Modeling & Simulation.”

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