This paper presents evidence that precautionary liquidity concerns lead many individuals to pay credit card bills even at the cost of mortgage delinquencies and foreclosures. While the popular press and some recent literature have suggested that this choice may emerge from steep declines in housing prices, we find evidence that individual-level liquidity concerns are more important in this decision. That is, choosing credit cards over housing suggests a precautionary liquidity preference.
By linking the mortgage delinquency decisions to individual-level credit conditions, we are able to assess the compound impact of reductions in housing prices and retrenchment in the credit markets. Indeed, we find the availability of cash-equivalent credit to be a key component of the delinquency decision. We find that a one standard deviation reduction in available credit elicits a change in the predicted probability of mortgage delinquency that is similar in both direction and nearly double in magnitude to a one standard deviation reduction in housing price changes (the values are -25% and -13% respectively). Our findings are consistent with consumer finance literature that finds individuals have a preference for preserving liquidity-even at significant cost.
This paper was revised in January 2010.