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How Do Foreclosures Exacerbate Housing Downturns?

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  • Adam M. Guren

    () (Boston University)

  • Timothy J. McQuade

    () (Stanford University)

Abstract

We present a dynamic search model in which foreclosures exacerbate housing busts and delay the housing market;s recovery. By eroding lender equity, destroying the credit of potential buyers, and making buyers more selective, foreclosures freeze the market for non-foreclosures can cause price-default spirals that amplify an initial shock. To quantitatively asses these channels, the model is calibrated to the recent bust. The amplification is significant: ruined credit and choosey buyers account for 22.5 percent of the total decline in non-distressed prices and lender losses account for an additional 30 percent. We use our model to evaluate foreclosure mitigation policies and find that payment reduction is quite effective, but creating a single seller of foreclosures that holds them off the market until demand picks up is the most effective policy. Policies that slow down the pace of foreclosures can be counterproductive.

Suggested Citation

  • Adam M. Guren & Timothy J. McQuade, "undated". "How Do Foreclosures Exacerbate Housing Downturns?," Boston University - Department of Economics - Working Papers Series WP2018-007, Boston University - Department of Economics.
  • Handle: RePEc:bos:wpaper:wp2018-007
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    Cited by:

    1. Atif Mian & Amir Sufi, 2018. "Finance and Business Cycles: The Credit-Driven Household Demand Channel," Journal of Economic Perspectives, American Economic Association, vol. 32(3), pages 31-58, Summer.
    2. Diamond, Rebecca & Guren, Adam & Tan, Rose, 2020. "The Effect of Foreclosures on Homeowners, Tenants, and Landlords," Research Papers 3877, Stanford University, Graduate School of Business.
    3. Hongfei Sun & Chenggang Zhou & Allen Head, 2016. "Default, Mortgage Standards, and Housing Liquidity," 2016 Meeting Papers 625, Society for Economic Dynamics.
    4. 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.
    5. Eric Zwick & Charles Nathanson & Anthony DeFusco, 2017. "Speculative Dynamics of Prices and Volume," 2017 Meeting Papers 239, Society for Economic Dynamics.
    6. David Berger & Nicholas Turner & Eric Zwick, 2016. "Stimulating Housing Markets," NBER Working Papers 22903, National Bureau of Economic Research, Inc.
    7. Do, Hung Xuan & Rösch, Daniel & Scheule, Harald, 2018. "Predicting loss severities for residential mortgage loans: A three-step selection approach," European Journal of Operational Research, Elsevier, vol. 270(1), pages 246-259.

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    More about this item

    Keywords

    Housing Prices & Dynamics; Foreclosures; Search; Great Recession;
    All these keywords.

    JEL classification:

    • E30 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - General (includes Measurement and Data)
    • R31 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - Real Estate Markets, Spatial Production Analysis, and Firm Location - - - Housing Supply and Markets

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