The Foreclosure-House Price Nexus: Lessons from the 2007-2008 Housing Turmoil
Despite housing's importance to the economy and worries about recent financial and economic turmoil traceable to housing market difficulties, little has been written on how distress in the housing market, measured by foreclosures, affects home prices, or how these variables interact with other macroeconomic or housing variables such as employment, housing permits or sales. Employing a panel VAR model to examine quarterly state-level data, our paper is the first to systematically analyze these interactions. There is substantial regional variation across states, which facilitates our ability to identify linkages among variables. Importantly, price-foreclosure linkages work in both directions; foreclosures have a significant, negative effect on home prices, while an increase in prices alleviates distress by lowering foreclosures. Similarly, employment and foreclosures have mutually negative effects on each other. The impact of foreclosures on prices, while negative and significant, is quite small in magnitude. We demonstrate this by simulating house price changes in response to extreme foreclosure shocks. Even under extremely pessimistic scenarios for foreclosure shocks, average U.S. house prices, as measured by the comprehensive OFHEO house price index (which we argue is the most reliable and useful measure of house prices to use for our purposes), likely would decline only slightly or remain essentially flat in response to foreclosures like those predicted for the 2008-2009 period. This suggests that home prices are quite sticky, and that fears of a major fall in house prices, with all of its attendant negative macroeconomic consequences, typically are not warranted even in extreme foreclosure circumstances.
The authors thank Inessa Love for sharing her panel VAR programs using Helmert de-meaning, and Mark Zandi for sharing Economy.com data and forecasts. The authors are also grateful to Jay Brinkmann, Michael Carliner, Robert Martin, Chris Mayer, Joseph Nichols, and Mark Zandi for helpful comments and suggestions. An earlier version of this paper circulated under the title "The Foreclosure Crisis: How Far Will House Prices Fall?" Calomiris is Henry Kaufman Professor of Financial Institutions at Columbia Business School and Research Associate, National Bureau of Economic Research. Longhofer is Stephen L. Clark Chair of Real Estate and Finance, and Director, Center for Real Estate, Barton School of Business, Wichita State University. Miles is Associate Professor of Economics and Barton Fellow, Wichita State University. The views expressed herein are those of the author(s) and do not necessarily reflect the views of the National Bureau of Economic Research.