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Explaining the Boom-Bust Cycle in the U.S. Housing Market: A Reverse-Engineering Approach

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Abstract

We use a simple quantitative asset pricing model to “reverse-engineer” the sequences of stochastic shocks to housing demand and lending standards that are needed to exactly replicate the boom-bust patterns in U.S. household real estate value and mortgage debt over the period 1995 to 2012. Conditional on the observed paths for U.S. disposable income growth and the mortgage interest rate, we consider four different specifications of the model that vary according to the way that household expectations are formed (rational versus moving average forecast rules) and the maturity of the mortgage contract (one-period versus long-term). We find that the model with moving average forecast rules and long-term mortgage debt does best in plausibly matching the patterns observed in the data. Counterfactual simulations show that shifting lending standards (as measured by a loan-to-equity limit) were an important driver of the episode while movements in the mortgage interest rate were not. Our results lend support to the view that the U.S. housing boom was a classic credit-fueled bubble involving over-optimistic projections about future housing values, relaxed lending standards, and ineffective mortgage regulation.

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  • Gelain, Paolo & Lansing, Kevin J. & Natvik, Gisele J., 2015. "Explaining the Boom-Bust Cycle in the U.S. Housing Market: A Reverse-Engineering Approach," Working Paper Series 2015-2, Federal Reserve Bank of San Francisco.
  • Handle: RePEc:fip:fedfwp:2015-02
    DOI: 10.24148/wp2015-02
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    Cited by:

    1. Paolo Gelain & Kevin J Lansing & Gisle James Natvik, 2018. "Leaning Against the Credit Cycle," Journal of the European Economic Association, European Economic Association, vol. 16(5), pages 1350-1393.
    2. Hull, Isaiah, 2015. "What Broke First? Characterizing Sources of Structural Change Prior to the Great Recession," Working Paper Series 301, Sveriges Riksbank (Central Bank of Sweden).
    3. repec:eee:jbfina:v:101:y:2019:i:c:p:161-172 is not listed on IDEAS
    4. Lansing, Kevin J., 2017. "Endogenous Regime Switching Near the Zero Lower Bound," Working Paper Series 2017-24, Federal Reserve Bank of San Francisco.
    5. Nelson Lind, 2017. "Credit Regimes and the Seeds of Crisis," 2017 Meeting Papers 1474, Society for Economic Dynamics.

    More about this item

    Keywords

    Housing bubbles; Mortgage debt; Borrowing constraints; Lending standards; macroprudential policy.;

    JEL classification:

    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • O40 - Economic Development, Innovation, Technological Change, and Growth - - Economic Growth and Aggregate Productivity - - - General
    • 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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