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Illiquidity and its discontents: Trading delays and foreclosures in the housing market

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  • Hedlund, Aaron

Abstract

The macroeconomic effects of housing illiquidity are analyzed using a novel directed search model of housing with long-term debt and default. Debt overhang emerges when highly leveraged sellers are forced to post high prices that produce long selling delays. These delays increase foreclosures, raise default premia, and curtail credit. Cheaper credit fuels temporarily higher house prices, faster sales, and fewer foreclosures, but the borrowing surge facilitates future debt overhang and default. More stringent foreclosure punishments also expand credit and, therefore, either generate higher foreclosures or more debt overhang. Leverage caps avoid this conundrum but reduce welfare by restricting borrowing.

Suggested Citation

  • Hedlund, Aaron, 2016. "Illiquidity and its discontents: Trading delays and foreclosures in the housing market," Journal of Monetary Economics, Elsevier, vol. 83(C), pages 1-13.
  • Handle: RePEc:eee:moneco:v:83:y:2016:i:c:p:1-13
    DOI: 10.1016/j.jmoneco.2016.08.005
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    Cited by:

    1. Adam M Guren & Timothy J McQuade, 2020. "How Do Foreclosures Exacerbate Housing Downturns?," Review of Economic Studies, Oxford University Press, vol. 87(3), pages 1331-1364.
    2. Essi Eerola & Niku Maattanen, 2018. "Borrowing constraints and housing market liquidity," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 27, pages 184-204, January.
    3. Miroslav Gabrovski & Victor Ortego-Marti, 2018. "Search and Credit Frictions in the Housing Market," Working Papers 201816, University of California at Riverside, Department of Economics.
    4. Rincón-Zapatero, Juan Pablo & Jerez, Belén & Díaz, Antonia, 2019. "Housing Prices and Credit Constraints in Competitive Search," UC3M Working papers. Economics 28874, Universidad Carlos III de Madrid. Departamento de Economía.
    5. Liberati, Danilo & Loberto, Michele, 2019. "Taxation and housing markets with search frictions," Journal of Housing Economics, Elsevier, vol. 46(C).
    6. Randall Wright & Philipp Kircher & Benoit Julîen & Veronica Guerrieri, 2017. "Directed Search: A Guided Tour," NBER Working Papers 23884, National Bureau of Economic Research, Inc.
    7. Bielecki, Marcin & Stähler, Nikolai, 2018. "Labor tax reductions in Europe: The role of property taxation," Discussion Papers 30/2018, Deutsche Bundesbank.
    8. Hedlund, Aaron, 2018. "Credit constraints, house prices, and the impact of life cycle dynamics," Economics Letters, Elsevier, vol. 171(C), pages 202-207.

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