Housing and the Financial Crisis
November 17-18, 2011
Todd M. Sinai
Sinai describes six stylized patterns among housing markets in the United States that potential explanations of the housing boom and bust should seek to explain. First, individual housing markets in the United States experienced considerable heterogeneity in the amplitudes of their cycles. Second, the areas with the biggest boom-bust cycles in the 2000s also had the largest boom-busts in the 1980s and 1990s, with a few telling exceptions. Third, the timing of the cycles differed across housing markets. Fourth, the largest booms and busts, and their timing, seem to be clustered geographically. Fifth, the cross-sectional variance of annual house price changes rises in booms and declines in busts. Finally, these stylized facts are robust to controlling for housing demand fundamentals - namely, rents, incomes, or employment - although changes in fundamentals are correlated with changes in prices.
Andrew Haughwout, Richard Peach, John Sporn, and Joseph Tracy, Federal Reserve Bank of New York
The boom and subsequent bust of housing construction and prices over the 2000s is widely regarded as a principal contributor to the Financial Panic of 2007 and the subsequent "Great Recession". As of this writing, housing market activity remains at depressed levels as the economy slowly resolves the legacy of excess supply and sharply lower prices. Over 2.6 million foreclosures have been completed since 2008 and 1.9 million foreclosures in process. Much has been written about the demand side of this pronounced housing cycle, in particular the innovations in mortgage finance and loosening of underwriting standards that greatly expanded the pool of potential home buyers. In this paper, Haughwout, Peach, Sporn, and Tracy take a closer look at developments on the supply side of the housing market. Following a short literature review, they begin with a descriptive review of housing production, sales, and prices at the national, regional, and state levels. They then look at developments in the home building industry over this period. They also take a closer look at land markets using a quarterly price index for MSAs with both elastic and inelastic housing supplies across the United States. An important question is to what extent the supply side of the market contributed to the boom/bust dynamics. A second question is whether the significant changes in the industrial organization of the home building industry exacerbated or ameliorated this supply impact.
David Genesove, Hebrew University, and Lu Han, University of Toronto
Recent work by Glaeser, Gyouko, and Saiz (2008) shows that house prices increase more during bubbles in places where housing supply is less elastic. Genesove and Han follow their insight and explore the role of a new supply proxy - commuting time - in explaining the within-market and cross-market variation in how house prices vary with stages of the market cycle. In their within-market analysis, they use a national panel of the house-level price data between 2005 and 2010 to examine the relationship between the price growth of a house and its proximity to the employment center. They find that the price gradient became flatter in the bust, implying that prices fell more in the center than at the city's edge. In the cross-market analysis, they use the city-level house price indices between 1975 and 2009 and find that when prices increase by 1 percent in a city with the mean average commuting time, prices increase by 1.1 percent in a city with one-standard deviation greater commuting time. Turning to the quantity response, they find that an increase in price is associated with a much larger percentage increase in the total building permits in cities with shorter average commuting time.
Donghoon Lee, Christopher Mayer, and Joseph Tracy, Federal Reserve Bank of New York
Lee, Mayer, and Tracy use data from credit report and deeds records to better understand the origination and subsequent performance of second liens. Second liens were quite prevalent at the top of the housing market, with as many as 45 percent of home purchases involving a piggyback second lien in coastal markets and bubble locations. Owner-occupants were more likely to use piggyback second liens than investors. Second liens originated as home equity lines of credit (HELOCs) were originated to relatively high quality borrowers and originations were declining near the peak of the housing boom. By contrast, closed-end second lien (CES) characteristics are worse on all of these dimensions. Default rates of second liens are generally similar to those of the first lien on the same home, although HELOCs perform better than CES. About 20-30 percent of borrowers will pay the second lien for more than a year while remaining seriously delinquent on their first mortgage. By comparison, about 40 percent of credit card borrowers and 70 percent of auto loan borrowers will continue making payments a year after defaulting on their first mortgage. Finally, the authors show that second liens' performance, especially HELOCs, has deteriorated recently, an area of concern for lenders with large portfolios of second liens on their balance sheet.
Edward L. Glaeser; Joshua D. Gottlieb, Harvard University; and Joseph Gyourko, University of Pennsylvania and NBER
Between 1996 and 2006, real housing prices rose by 53 percent according to the Federal Housing Finance Agency price index. One explanation of this boom is that it was caused by easy credit in the form of low real interest rates, high loan-to-value levels and permissive mortgage approvals. Glaeser, Gottlieb, and Gyourko revisit the standard user cost model of housing prices and conclude that the predicted impact of interest rates on prices is much lower once the model is generalized to include mean-reverting interest rates, mobility, prepayment, elastic housing supply, and credit-constrained home buyers. The modest predicted impact of interest rates on prices is in line with empirical estimates, and it suggests that lower real rates can explain only one-fifth of the rise in prices from 1996 to 2006. They also find no convincing evidence that changes in approval rates or loan-to-value levels can explain the bulk of the changes in house prices, but definitive judgments on those mechanisms cannot be made without better corrections for the endogeneity of borrowers' decisions to apply for mortgages.
Benjamin Keys, Federal Reserve Board; Tomasz Piskorski, Columbia University; Amit Seru, University of Chicago and NBER; and Vikrant Vig, London School of Business
Keys, Piskorski, Seru, and Vig track the evolution of financing of residential real estate through the housing boom in the early-to-mid-2000s and the resolution of distress during the bust during the late 2000s. Financial innovation, in the form of non-traditional mortgage products and the expansion of alternative lending channels, namely non-agency securitization, fundamentally altered the mortgage landscape during the boom. The authors describe the impact of these changes in mortgage finance on borrowers and loan performance, as well as their impact on the resolution of distressed mortgages. They summarize the existing research and argue that the form of financial intermediation had a direct impact on lending standards and on the potential for renegotiating residential loans. In addition, they provide new evidence on agency conflicts in the securitization process, and detail broader challenges to cost-effective mortgage renegotiation. They conclude by considering what lessons for the future of mortgage finance can be drawn from the recent housing boom and bust episode.
Dwight Jaffee and John M. Quigley, University of California at Berkeley
Jaffee and Quigley analyze options for reforming the U.S. housing finance system in view of the failure of Fannie Mae and Freddie Mac as government sponsored enterprises (GSEs). The options considered include GSE reform, a range of possible new governmental mortgage guarantee plans, and greater reliance on private mortgage markets. The analysis also considers the larger question of the proper role for government in the U.S. housing and mortgage markets. The authors start by reviewing the history of the GSEs and their contributions to the operation of U.S. housing and mortgage markets, including the actions that led to their failure in conjunction with the recent mortgage market crisis. The reform options they consider include those proposed in a 2011 U.S. Treasury White Paper, plans for new government mortgage guarantees from various researchers and organizations, and the evidence from Western European countries for the efficacy of private mortgages markets.
Jack Favilukis, London School of Economics; David Kohn, New York University; and Sydney C. Ludvigson and Stijn Van Nieuwerburgh, New York University and NBER
The last 15 years have been marked by a dramatic boom-bust cycle in real estate prices and accompanied by economically large fluctuations in international capital flows. Favilukis, Kohn, Ludvigson, and Van Nieuwerburgh argue that changes in international capital flows played, at most, a small role in driving house price movements in this episode and that, instead, the key causal factor was a financial market liberalization and its subsequent reversal. Using observations on credit standards, capital flows, and interest rates, the authors find that a bank survey measure of credit supply, by itself, explains 53 percent of the quarterly variation in house price growth in the U.S. over the period 1992-2010, while it explains 66 percent over the period since 2000. By contrast, once they control for credit supply, various measures of capital flows, real interest rates, and aggregate activity - collectively - add less than 5 percent to the fraction of variation explained for these same movements in home values. Credit supply retains its strong marginal explanatory power controlling for expectations of future economic events and becomes even more important, relative to expectations, in predicting future house price movements.