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New Study by ODU's Seiler Suggests Homeowners Favor Penalizing Mortgage Lenders They Perceive as Unfair

It's a common perception that the actions of the nation's financial institutions helped bring on the current economic malaise, or at least make the symptoms worse. Yet many of these financial institutions received a government bailout when the country's entire financial system was at risk.

A new study by Old Dominion University's Michael Seiler, however, suggests that there's a disconnect between what homeowners believe about their financial institution and what actually occurred in helping precipitate the financial crisis. And that lack of connectivity may be part of what motivates homeowners to walk away, or strategically default, on their mortgage.

Seiler, founder and director of the Institute for Behavioral and Experimental Real Estate (IBERE), and professor and Robert M. Stanton Chair of Real Estate and Economic Development in ODU's College of Business and Public Administration, has authored a paper that suggests homeowners are willing to "punish" mortgage lenders who they believe have acted inappropriately.

"Studies of ultimatum games have long documented that individuals are willing to sacrifice personal wealth in order to financially penalize players they perceive to be acting selfishly or unfairly," Seiler writes in his new paper, "The Effect of Perceived Lender Characteristics and Market Conditions on Strategic Mortgage Defaults."

The study applies ultimatum game theory to strategic mortgage default decisions, and finds that individual homeowners are more likely to walk away from their mortgage if they perceive their lender more negatively.

A strategic default is different from an economic default, where a homeowner simply has no ability to pay a mortgage. Strategic default is the conscious decision of a homeowner to stop making mortgage payments even though he or she can afford it, because that course of action is seen to be more beneficial. Seiler has done several studies on the damage that an epidemic of strategic defaults can have on the entire economy.

This study asked a sample of nearly 1,000 homeowners a series of scenario questions under ultimatum game theory, which revealed a constant thread of reaction to perceived "unfair" financial dealings - homeowners were willing to sacrifice personal wealth in order to penalize the other side. "When they perceive a person as not being equitable, they derive more utility from seeing the lender get penalized than they do from receiving extra money," Seiler said.

This study suggests that this scenario could manifest itself in dealings with financial institutions, even though some homeowners who strategically default are doing so under a false premise.

The banks are perceived to be a net negative to society by the homeowner sample group, which in this study demonstrates an extreme "mismatch" between perceptions of bank behavior and the banks' actual behavior. "Borrowers have virtually no idea which banks have and have not received government bailout funds, not even their own bank," Seiler said.

Among the other findings of the study, homeowners are found to be far more willing to strategically default when working with a nameless, faceless online financial institution, rather than local banks with whom they have an ongoing relationship.

That tendency is more pronounced in homeowners who have been denied a loan modification, those who have previously defaulted on a mortgage, those under age 45, those with a higher positive net worth and male study participants.

The lending industry can interpret from these findings that the owner of the loan (typically Fannie Mae or Freddie Mac) should choose as a servicer an institution that did not receive government bailout funds, has a local market presence in the community in which the loan is originated, and has an otherwise clean public image. This loan servicer who is perceived to have behaved well throughout the crisis would then seem to be able to reduce the delinquency rate of loans they service, Seiler said.