“How did you go bankrupt?”
“Two ways. Gradually and then suddenly.”
— Ernest Hemingway, The Sun Also Rises
Annex I. Estimating Mortgage Arrears Using Macroeconomic Indicators
Data on mortgage arrears in the UK span several decades, providing a suitable time series for estimating macroeconomic determinants of arrears. The relatively short time series of mortgage arrears available for Iceland, Ireland, Spain or the US limits the robustness of estimating country specific models. For the UK, however, detailed statistics on mortgage arrears are available from the Council of Mortgage Lenders starting in 1970. Also, the UK has in place a well tested framework for resolving arrears that has not undergone significant changes since 1986.
Using UK data, the level of mortgage arrears is regressed on unemployment, house prices, and debt service ratios. The sample period for mortgage arrears starts in 1987 and encompasses two housing cycles. Determinants of mortgage defaults include variables that are related to households’ willingness and ability to pay, following earlier empirical studies (Breedon and Joyce, 1993; Whitley et al., 2004). Households’ willingness to pay is proxied by changes of nominal house prices which affect housing wealth and negative equity. Ability to pay is proxied by the unemployment rate, given that unemployment often triggers debt distress, and the ratio of total debt service over income.
This parsimonious specification yields a reasonable explanatory power and robustness. The dependent variable is the share of UK mortgages more than three months past due at a quarterly frequency, using linear interpolation for semiannual arrears data prior to 2008. As explained above, the set of independent variables include: (i) the annual percentage change in the nominal house prices index (dHP); (ii) the unemployment rate (UE), measured as difference to its long term average; and (iii) the debt service ratio (DSR) based on an average sized mortgage loan with 20 years remaining maturity at the current mortgage interest rate, expressed in percent of average household income. The regression is specified similar to Breedon and Joyce (1993) to describe long run arrears dynamics:
Independent variables are lagged by two quarters. Coefficients are significantly different from zero and with the expected sign, although the debt service coefficient is small relative to the variance of observed debt service ratios. The specification achieves an adjusted R2 of 0.65. Alternative specifications, such as using logs, yield broadly similar results.
The estimated coefficients are used to project arrears levels in Iceland, Ireland, Spain, and the US. This relative analysis attempts to compare arrears levels between countries while controlling for some macroeconomic determinants. Resulting differences between observed and projected arrears levels could suggest different sensitivities to macroeconomic drivers, such as fewer defaults in response to house price slumps in jurisdictions with full recourse. Differences could also be explained by unobserved factors, such as the duration or cost of foreclosure procedures, or the distribution of debt and the impact of macroeconomic shocks across households.
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I would like to thank Craig Beaumont, Ashok Bhatia, Kevin Fletcher, Mary Goodman, Kenneth Kang, Michael Moore and seminar participants at the IMF, the Central Bank of Ireland, and De Nederlandsche Bank for helpful discussions and comments. I am indebted to Sergei Antoshin, Wolfgang Bergthaler, Mali Chivakul, Jihad Dagher, Deniz Igan, Heedon Kang, Pablo Lopez Murphy, Oana Nedelescu, Jarkko Turunen, as well as staffs of the Banco de España, the Central Bank of Ireland, the Central Statistics Office of Ireland, the Insolvency Service Ireland, and the Seôlabanki Íslands for advice and help regarding country experiences and data. Vizhdan Boranova provided excellent research assistance.