Foreclosures, House Prices, and the Real Economy

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Increased foreclosures are associated with a decrease in permits for new residential construction and a decline in auto sales.

In Foreclosures, House Prices, and the Real Economy (NBER Working Paper No. 16685), co-authors Atif Mian, Amir Sufi, and Francesco Trebbi demonstrate that foreclosures not only reduce house prices but also were an important factor in weak residential investment and in durable consumption patterns during and after the recession of 2007-9.

The researchers analyze a household-level dataset covering the entire United States until the end of 2009. The dataset includes information on house prices, residential investment, auto sales, mortgage delinquencies, foreclosures, and other variables. This study is unique in its focus on how the state-by-state variation in foreclosures may be driven by state rules regarding whether a foreclosure must be sanctioned by a court. In 21 states, a lender must sue a borrower in court before conducting an auction to sell the property. In states without this requirement, lenders may sell a house after providing only a notice of sale to the borrower.

The researchers find that states that require a judicial foreclosure had a 3 percentage point lower rate of foreclosures per homeowner during 2008 and 2009 than states without that requirement. Using data on mortgage delinquencies, they also show that states with judicial requirements had a much lower ratio of foreclosures to delinquent accounts. In fact, none of the 14 states with the highest propensity to convert delinquent homes into foreclosure sales require judicial foreclosure.

Aside from these differences in foreclosure rates, the researchers observe that states with a judicial foreclosure requirement are remarkably similar to states without such a requirement. For example, as of the year 2000 there was no difference in the fraction of subprime borrowers, the fraction of lower-income residents, the unemployment rate, the minority share of the population, and the fraction of the residents living in urban areas between the two groups of states. Similarly, there was no evidence of differential credit growth or differential house price growth between 2000 and 2005, and no difference in mortgage delinquency rates during the mortgage default crisis, between the two groups.

Mian, Sufi, and Trebbi further find that moving from the median rate of foreclosures to the 90th percentile foreclosure rate is associated with 9 percent lower growth in house prices from 2007 to 2009. Increased foreclosures also are associated with a decrease in permits for new residential construction and a decline in auto sales. All of these estimates of the effect of foreclosures control for demographics and for income differences across states.

Mian, Sufi, and Trebbi then use their estimates to quantify the aggregate effects of foreclosures on the macroeconomy. They conclude that foreclosures were responsible for 15-30 percent of the decline in residential investment from 2007 to 2009 and 20-40 percent of the decline in auto sales over the same period.

--Matt Nesvisky