How Do Foreclosures Exacerbate Housing Downturns?

Adam Guren and Timothy J. McQuade

No 26216, NBER Working Papers from National Bureau of Economic Research, Inc

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.

JEL-codes: E30 R31 (search for similar items in EconPapers)
Date: 2019-08
New Economics Papers: this item is included in nep-cmp, nep-dge, nep-mac and nep-ure
Note: EFG
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (9)

Published as Adam M Guren & Timothy J McQuade, 2020. "How Do Foreclosures Exacerbate Housing Downturns?," The Review of Economic Studies, vol 87(3), pages 1331-1364.

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Related works:
Journal Article: How Do Foreclosures Exacerbate Housing Downturns? (2020)
Working Paper: How Do Foreclosures Exacerbate Housing Downturns? (2015)
Working Paper: How Do Foreclosures Exacerbate Housing Downturns?
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