Working Paper: NBER ID: w26216
Authors: Adam M. Guren; Timothy J. McQuade
Abstract: This paper uses a structural model to show that foreclosures played a crucial role in exacerbating the recent housing bust and to analyze 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 percent of the total decline in non-distressed prices and lender losses account for an additional 22.6 percent. 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.
Keywords: foreclosures; housing downturns; mitigation policy; structural model
JEL Codes: E30; R31
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Foreclosures (G33) | Reduced lender equity (G21) |
| Reduced lender equity (G21) | Lender rationing of mortgage credit (G21) |
| Lender rationing of mortgage credit (G21) | Reduced number of buyers in the market (D49) |
| Foreclosures (G33) | Foreclosure flag on credit record (G21) |
| Foreclosure flag on credit record (G21) | Decreased number of buyers in the market (D49) |
| Presence of distressed sales (G33) | Increased buyer selectivity (D49) |
| Increased buyer selectivity (D49) | Lower nondistressed sales (R33) |
| Foreclosures (G33) | Price-default spiral (D43) |
| Lender losses (G21) | Decline in nondistressed prices (E30) |
| Ruined credit and choosey buyers (G51) | Decline in nondistressed prices (E30) |