The Role of Default (Not Bankruptcy) as Unemployment Insurance: New Facts and Theory
80 Pages Posted: 25 Jan 2013
Date Written: October 28, 2012
Abstract
How do job losers use default -- a phenomenon 6x more prevalent than bankruptcy -- as a type of "informal" unemployment insurance, and more importantly, what are the social costs and benefits of this behavior? To this end, I establish several new facts: (i) job loss is the main reason for default, not negative equity (ii) people default because they are credit constrained and cannot borrow more, and (iii) the value of debt payments is a significant fraction of a defaulter's earnings. Using these facts, I calibrate a general equilibrium model with a frictional labor market similar to Menzio and Shi (2009, 2011) and individually priced debt along the lines of Eaton and Gersovitz (1981) and Chatterjee et al. (2007). After proving the existence of a Block Recursive Equilibrium, I find that the extra self-insurance job losers obtain by defaulting outweighs the subsequent increase in the cost of credit, and as a result, protectionist policies such as the Mortgage Servicer Settlement of 2012 or the CARD Act of 2009 improve overall welfare by .1%. The side effect of the policies, however, is a .2 to .5% higher unemployment rate during recessions that persists throughout the recovery.
Keywords: Default, Delinquency, Foreclosure, PSID 2009 Mortgage Distress, Unemployment Benefits, Block Recursive, Bankruptcy, Search, Matching, Mortensen Pissarides, Unemployment, Unemployment Insurance, Insurance, Labor, Recovery, Business Cycle
JEL Classification: E24, E32, E44, G2, J6, K35
Suggested Citation: Suggested Citation
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