Economics, Mortgages, and Civic Virtue

In our chapter on economic policy, we discuss how mortgage defaults helped bring about the financial turmoil of recent years. But while things are bad, they could be much worse. Kevin Hassett of the American Enterprise Institute writes:

The puzzling fact is that Americans have not walked away from their debts in large numbers--at least so far. Only about 10 percent of those with negative equity have defaulted. Why have so few done the "economically rational" thing? And is the wave still coming, or is there something about Americans that makes them unwilling to default, even when it is in their immediate interest to do so?

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Economists Luigi Guiso, Paola Sapienza, and Luigi Zingales set out to better understand the drivers of strategic de fault, using a novel approach for econ omists: They surveyed homeowners about their willingness to default on their mortgages under a number of hypo­thetical circumstances.

The results were startling. Fully 80 percent of individuals said they thought it would be "morally wrong" to strategically default on their mortgages. The economists correlated these responses with default behavior and found that moral beliefs indeed influence decisions: Individuals were 77 percent less likely to declare their intention to de fault if they said it would be morally wrong to do so.

The moral constraint is far from perfect: if people see their neighbors getting away with defaulting , they are more likely to do so themselves. This mix of virtue and vice would not have surprised Madison.