How Do Foreclosures Exacerbate Housing Downturns?

Adam Guren and Timothy J McQuade

The Review of Economic Studies, 2020, vol. 87, issue 3, 1331-1364

Abstract: This article uses a structural model to show that foreclosures played a crucial role in exacerbating the recent housing bust and to analyse 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% of the total decline in non-distressed prices and lender losses account for an additional 22.6%. 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: Housing prices and dynamics; Foreclosures; Search; Great recession; E30; R31 (search for similar items in EconPapers)
Date: 2020
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Citations: View citations in EconPapers (20)

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Related works:
Working Paper: How Do Foreclosures Exacerbate Housing Downturns? (2019)
Working Paper: How Do Foreclosures Exacerbate Housing Downturns? (2015)
Working Paper: How Do Foreclosures Exacerbate Housing Downturns?
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