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Systemic risk and the refinancing ratchet effect

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Author Info

  • Khandani, Amir E.
  • Lo, Andrew W.
  • Merton, Robert C.

Abstract

The combination of rising home prices, declining interest rates, and near-frictionless refinancing opportunities can create unintentional synchronization of homeowner leverage, leading to a “ratchet” effect on leverage because homes are indivisible and owner-occupants cannot raise equity to reduce leverage when home prices fall. Our simulation of the U.S. housing market yields potential losses of $1.7 trillion from June 2006 to December 2008 with cash-out refinancing vs. only $330 billion in the absence of cash-out refinancing. The refinancing ratchet effect is a new type of systemic risk in the financial system and does not rely on any dysfunctional behaviors.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Financial Economics.

Volume (Year): 108 (2013)
Issue (Month): 1 ()
Pages: 29-45

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Handle: RePEc:eee:jfinec:v:108:y:2013:i:1:p:29-45

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Web page: http://www.elsevier.com/locate/inca/505576

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Keywords: Systemic risk; Financial crisis; Household finance; Real estate; Subprime mortgage;

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Citations

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Cited by:
  1. Ebner, André, 2010. "A micro view on home equity withdrawal and its determinants. Evidence from Dutch households," Discussion Papers in Economics 11309, University of Munich, Department of Economics.
  2. Buiter, Willem H, 2008. "Housing Wealth isn't Wealth," CEPR Discussion Papers 6920, C.E.P.R. Discussion Papers.
  3. John Y. Campbell, 2012. "Mortgage Market Design," NBER Working Papers 18339, National Bureau of Economic Research, Inc.
  4. Guharay, Samar K. & Thakur, Gaurav S. & Goodman, Fred J. & Rosen, Scott L. & Houser, Daniel, 2013. "Analysis of non-stationary dynamics in the financial system," Economics Letters, Elsevier, vol. 121(3), pages 454-457.
  5. John Y. Campbell & Howell E. Jackson & Brigitte C. Madrian & Peter Tufano, 2011. "Consumer Financial Protection," Journal of Economic Perspectives, American Economic Association, vol. 25(1), pages 91-114, Winter.
  6. Manuel Adelino & Antoinette Schoar & Felipe Severino, 2012. "Credit Supply and House Prices: Evidence from Mortgage Market Segmentation," NBER Working Papers 17832, National Bureau of Economic Research, Inc.
  7. Huang, MeiChi, 2014. "Bubble-like housing boom–bust cycles: Evidence from the predictive power of households’ expectations," The Quarterly Review of Economics and Finance, Elsevier, vol. 54(1), pages 2-16.
  8. Ebrahim, M. Shahid & Shackleton, Mark B. & Wojakowski, Rafal M., 2011. "Participating mortgages and the efficiency of financial intermediation," Journal of Banking & Finance, Elsevier, vol. 35(11), pages 3042-3054, November.
  9. Pol, Eduardo, 2012. "The preponderant causes of the USA banking crisis 2007–08," Journal of Behavioral and Experimental Economics (formerly The Journal of Socio-Economics), Elsevier, vol. 41(5), pages 519-528.

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