Hdsi

Household Debt and Social Interactions#
Dimitris Georgarakos
Goethe University Frankfurt and CFS

Michael Haliassos
Goethe University Frankfurt, CFS and CEPR

Giacomo Pasini
University Ca’ Foscari of Venice and NETSPAR

June 20, 2012 Abstract Debt-induced crises, including the subprime, are usually attributed exclusively to supply-side factors. We examine the role of social influenceson debt culture, emanating from perceived average income of peers. Utilizing unique information from a household survey representative of the Dutch population, that circumvents the issue of defining the social circle, we consider collateralized, consumer, and informal loans. We find robust social effects on borrowing, especially among those who consider themselves poorer than their peers; and onindebtedness, suggesting a link to financial distress. We employ a number of approaches to rule out spurious associations and to handle correlated effects.

Keywords: Household finance, household debt, social interactions, mortgages, consumer credit, informal loans. JEL Classifications: G11, E21

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We would like to thank Rob Alessie, Bas Donkers, Yannis Ioannides, Mauro Mastrogiacomo, LuigiPistaferri, Dorothea Schäfer, Kostas Tatsiramos, and seminar participants at the: NETSPAR International Pension Workshop, Amsterdam; Behavioral Finance Conference, DIW, Berlin; 10th Conference on Economic Theory and Econometrics (CRETE), Greece; Association of Southern European Economic Theory (ASSET) conference in Evora, Portugal; GSEFM conference in Mainz; IAES Conference in Istanbul;Universities of Bath, Freiburg, and Southampton; CPB in Den Haag; and at the research department of Deutsche Bundesbank. Haliassos acknowledges research funding from the German Research Foundation (DFG).

Electronic copy available at: http://ssrn.com/abstract=2014222

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Introduction The recent financial crisis has demonstrated the potential of sizeable household

groups to borrow at levels thatexpose them to subsequent difficulties in servicing debts and to a non-trivial risk of default. For example, many US households had exposed themselves to excessive mortgage debt prior to the subprime crisis, and some ended up with negative equity following the reversal of historical house price trends. Existing literature and public discussion have paid attention, almost exclusively, to supply-sidefactors that may have contributed to this tendency, such as lax standards of the banking sector, the transfer of risks, and the resulting lack of discipline in applying sound banking standards.1 Much less attention has been devoted to understanding demand-side factors that contribute to the spread of debt culture, especially among households who perceive themselves as having fewer resources thantheir peers on average. An important example of such factors, albeit specific to the subprime crisis, is the subjective belief of borrowers that US house prices could not fall, based on the long historical experience of price increases.2 Our paper focuses on another factor, which could apply to all types of debt and has been explored only in other contexts: comparison with peers. If expectations orperceptions of relative standing are important for debt behavior, then regulation and monitoring of financial institutions may need to be combined with measures for households, such as financial education, proper advice, and appropriate default options, in order to contain the spread of debt culture and the risks for future debt-induced financial crises. The importance of relative standing in thesocial circle has long been recognized in the economics and finance literature, but for issues other than debt. Models with
See for example, Mian and Sufi (2009) who show that a shift in credit supply was a key factor in the expansion of subprime mortgages in the US; and Demyanyk and Van Hemert (2012) who find that the quality of such loans deteriorated for six consecutive years prior to the...