More than one in five borrowers have underwater mortgage loans—they owe more than their homes are worth. This causes financial stress and emotional pain, but new research shows that underwater mortgages may also cause homeowners to work for less money. In a working paper from the Federal Reserve Bank of Atlanta, researchers Chris Cunningham and Robert Reed found that all things being equal, having an underwater mortgage causes a 5 percent to 9 percent decline in real wages.
The paper is based on data from 1985 to 2003, but the researchers say it helps explain a perplexing aspect of the current recovery—that corporate earnings have rebounded while wage growth has been weak. If so many homeowners have underwater mortgages—and therefore are not as demanding—employers can hire them for less. The paper finds that for every $10,000 a homeowner’s mortgage loan is underwater, he or she tends to accept 0.7 percent lower pay. The paper doesn’t make clear if this is for unemployed workers looking for a job or for current workers either taking pay cuts or switching jobs.
Cunningham and Reed found that the data don’t support the theory that underwater mortgages make it harder for people to move to a new area in search of a better job. Instead, they say, people take lower paying jobs because they don’t want to default on their mortgage loans. They cite research that has shown that people avoid defaulting for several reasons—including emotional connections to a place, fear of damaged credit scores, and hopes that prices will rebound—and that an underwater loan doesn’t, by itself, cause most people to default. Instead, it takes a secondary shock—like losing a job—to trigger a default. “The value of employment for a worker in a negative equity position is larger than others who have significant housing wealth,” Cunningham and Reed write. Because simply having a job is worth more to them, underwater borrowers will accept lower pay.
The downturn has caused economists to revisit the idea of “sticky wages” and why even in times of high unemployment, people don’t accept lower pay. “Actual cuts in nominal wages happen only rarely and under great pressure,” Paul Krugman wrote this summer. Some argue that unemployed workers should take lower-paying jobs to help clear the market and get the economy producing. Krugman, however, says that the sticky-wage phenomenon is generally good for the U.S. because it counters deflation.
Cunningham and Reed worry that the lower pay for underwater homeowners can create “a significant negative feedback loop—house price depreciation leads to lower wages, and in turn, lower wages lead to greater housing losses.” In essence, a double whammy for struggling borrowers.