How do foreclosures exacerbate housing downturns?
Guren, Adam M.
McQuade, Timothy J.
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Citation (published version)A. Guren, T. McQuade. 2020. "How Do Foreclosures Exacerbate Housing Downturns?." The Review of Economic Studies, Volume 87, Issue 3, pp. 1331 - 1364. https://doi.org/10.1093/restud/rdaa001
This article uses a structural model to show that foreclosures played a crucial role in exacerbating the recent housing bust and to analyse foreclosure mitigation policy. We consider a dynamic search model in which foreclosures freeze the market for non-foreclosures and reduce price and sales volume by eroding lender equity, destroying the credit of potential buyers, and making buyers more selective. These effects cause price-default spirals that amplify an initial shock and help the model fit both national and cross-sectional moments better than a model without foreclosure. When calibrated to the recent bust, the model reveals that the amplification generated by foreclosures is significant: ruined credit and choosey buyers account for 25.4% of the total decline in non-distressed prices and lender losses account for an additional 22.6%. For policy, we find that principal reduction is less cost-effective than lender equity injections or introducing a single seller that holds foreclosures off the market until demand rebounds. We also show that policies that slow down the pace of foreclosures can be counterproductive.
Rights© The Author(s) 2020. Published by Oxford University Press on behalf of The Review of Economic Studies Limited.