Social Norms and Strategic Default

Abstract

A significant share of the mortgage defaults in the U.S. during the 2007-2009 crisis were strategic. Survey evidence suggests that the willingness to default strategically is not only determined by financial incentives, but also by non-pecuniary motives such as moral constraints and social norms. In this paper we use experimental methods to shed new light on the behavioral mechanisms underlying the increased tendency to default strategically in an economic crisis. Our design allows us to directly observe the impact of exogenous variation in economic conditions on repayment behavior and norm enforcement. Our data reveals two important results: First, adverse economic conditions soften moral constraints. When economic shocks cause fundamental defaults to surrounding borrowers solvent households are more prone to default strategically. Second, an economic contraction weakens the enforcement of social norms: In a crisis, peers of defaulting households have a hard time distinguishing between strategic and fundamental defaults and are therefore reluctant to punish defaulting households.