How do foreclosures exacerbate housing downturns?
Files
Accepted manuscript
Date
2020-05
Authors
Guren, Adam M.
McQuade, Timothy J.
Version
Accepted manuscript
OA Version
Citation
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
Abstract
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.
Description
License
© The Author(s) 2020. Published by Oxford University Press on behalf of The Review of Economic Studies Limited.