For most people, housing is the largest routine expense they face and their most valuable asset. As a source of both wealth and household debt, housing markets influence not just individual consumption and savings but employment and consumer demand, with ripple effects all across the broader economy.
The subprime mortgage crisis, housing market collapse, and the global financial crisis that followed revealed that the magnitude and exact mechanisms of how housing markets feed into the economy are not well understood. Since the Great Recession, many economists jumped in to fill the gap, says Amir Sufi of the University of Chicago Booth School of Business.
“Tons of young scholars and faculty” have focused on this problem, and Sufi organized this Sept. 16 conference to bring together several who are working to explore the interplay between housing, household debt, and the macroeconomy. The event was the second in a continuing series rotating between Northwestern University, UChicago, and the Federal Reserve Bank of Chicago.
“We’re trying to take advantage fact that we believe that here in Chicago we have the strongest group of researchers working in the area. We’re really excited to build a community of people working on this problem,” Sufi said. The program was designed to “further our understanding but also foster interaction between a lot of junior researchers, to encourage interaction and coauthoring and collaboration.”
“We may not be able to predict where the next crises will arise, but we are adding to our understanding of what we’ve experienced and how to respond to problems,” Sufi added.
Effects of Homeownership
Some research presented at the conference took on basic assumptions about home ownership. Encouraging homeownership has been the policy of both Republicans and Democrats since the 1930’s, with many policy initiatives focusing on homeownership in low-income areas in particular. Overall, as is well known, high home ownership is associated with intergenerational mobility. However, the financial crisis has drawn attention to the downside of home-owning: in a housing crisis, negative equity can lock homeowners into an area.
As they say in the real estate business, location is everything. Nirupama Kulkarni of CAFRAL presented research that showed that the positive relationship between homeownership and intergenerational economic mobility is highly place-dependent. The relationship is weak or negative if the home purchase locks homeowners into areas of high sprawl or high segregation.
The findings suggest that home ownership may not benefit, or even disadvantage children in segregated, poor areas, possibly through reduced residential mobility, Kulkarni reported.
Adam Guren of Boston University presented work that estimated how decreased home sales cut into consumer spending.
In previous work, Mian (2013) used consumer-level data on auto sales and credit card purchases to document a large 1.7 percent drop in spending in response to the housing price drop of 2006-2009, concentrated in auto and durable goods sale.
Most earlier work has assumed that the main mechanism by which a drop in housing prices affects consumer spending and the economy has been either through a decline in household wealth, indirectly through local labor market depression, or through loss of potential collateral due to decreased equity in the house. Guren and coauthors examined a more direct effect, by looking at the decreased turnover in the housing sector during the crisis.
Buyers typically customize or fix up their new homes, so the authors looked at the Consumer Expenditure Survey for the months after a purchase. After a home purchase, spending on consumer durables more than triples; spending on home improvements doubles.
The authors estimate cumulative net spending increases of around $5,000 within a year of purchase for primary residences and $3,700 for all residences. This may underestimate the effect because the sample design omits home improvements by the seller prior to listing. Correlating that with the 50-percent decline in home sales seen in the Great Recession, the authors estimate that this effect can account for about three-quarters of the durable goods decline that Mian et al. documented.
Several papers presented explored the effects of policies adopted in response to the 2007 housing market collapse and financial crisis.
One response to the housing bust was the Home Affordable Refinance Program (HARP), which extended a government credit guarantee to cover loans which were insufficiently collateralized, to encourage lenders to refinance mortgages that were substantially under water. The intended effect was to stimulate consumer spending, limit foreclosures, and stabilize house prices.
Did it work? Tomasz Piskorski of Columbia Business School and colleagues studied data linking loans, refinancing history, and consumer credit records for a large sample of individual borrowers. They found that more than 3 million borrowers refinanced their mortgages under HARP, with an average 1.4 percent reduction in the interest rate (about 23 percent in relative terms) and an average of $3,500 in savings per borrower.
After refinancing, there was a greater than 10 percent increase in durable spending, with stronger effects among the more heavily indebted. There was substantial regional variation in the proportion of loans that were eligible for the program. regions more exposed to the program experienced higher spending growth in auto and credit cards, reductions in foreclosures, and an improvement in house prices.
However, the authors document some evidence of market frictions which limited the effectiveness of the program, especially for the most indebted. These findings have implications both future policy interventions and the design of the mortgage market.
The US housing market collapse produced a capital overhang—a high housing inventory that exceeded demand and distressed assets that were good deals, but potential buyers couldn’t finance them. One policy response was the First-Time Homebuyer Credit (FTHC), was a temporary, refundable tax credit for new homebuyers.
Eric Zwick of Chicago Booth and colleagues analyzed the efficacy of the First Time Homebuyer Credit program. Because different regions had different shares of potential first-time homeowners, they could isolate the effect of the policy. They found that the effect of the policy was mostly in existing, not new home sales; the program was primarily working by reallocating homes and stabilizing house prices.
Most of what they observe is consistent with first-time homebuyers purchasing earlier than they otherwise would have: the maximum credit offered in the later stage of the program, $8,000, on average results in buyers purchasing three years earlier than they otherwise would have.
The Role of Monetary Policy
How did quantitative easing work? There is considerable debate about the mechanism by which the Federal Reserve’s large-scale purchases of assets has real effects on the economy.
Amir Kermani of the University of California, Berkeley examined differences in prices and quantities of loans which were eligible for government guarantees and jumbo mortgages that were too large to qualify. He showed that there is considerable market segmentation within the mortgage market; the effects on both prices and refinancing quantities differ depending on whether a loan is qualifying or not.
During QE, the rates on qualifying loans were affected more than the rates on the jumbos. Qualifying loans saw an increase in refinancing, but jumbo loans did not. This suggests that segmentation in the mortgage market was an important channel by which QE was able to affect the economy.
Victor Rios-Rull presented a theoretical model of an economy in which shocks to the ability of households to borrow can generate large recessions. They then calibrate their model by matching the model’s distributions of wealth, housing wealth, and earnings to the real economy during the 2007 financial crisis.
The model’s ability to mimic the behavior of the real economy relies on frictions which limit the ability to switch production from consumption to exports or investment; frictions that allow house prices to fall; frictions in goods markets; households that differ in their job prospects; and frictions in the labor market that limit wage adjustments when productivity falls.
Housing price models struggle to explain the wide swings in the prices of houses. Further, we know from survey data collected by the New York Fed that there is often a wide cross-sectional dispersion of expectations of housing price outcomes within a given zip code.
One possible reason is that these swings are based on irrational expectations or bubbles in house prices. Robert Shiller has argued that excessive optimism in the last housing bubble was part of a “social epidemic. We know people’s own past experience of housing prices has a substantial impact on their future behavior in this market. Another influence, investigated by Johannes Strobel and colleague, may be the housing price experiences of friends.
Using anonymized data from Facebook, the authors looked at the effects of the housing experience of out-of-town Facebook friends on an individual’s propensity to invest in housing. The authors start with a sample of individuals in Los Angeles. Facebook friends living nearby were from the analysis, because they were likely to face a similar housing market. Because each individual in the sample linked to a different set of out-of-town friends, they were also exposed second-hand to a different set of housing markets.
Controlling for previous housing price experiences and demographics, the study showed that those with friends who saw larger home price increases in their neighborhoods were more likely to move from renting to owning. They were also more likely to buy a larger house, to pay more for any given house, and to make a larger down payment. Conversely, those whose friends reported bad fortune in the housing market were more likely to move from owning to renting and more likely to sell property at a lower price.
— Jennie France