Solved by verified expert :Federal
Reserve Bank of New York
Staff Reports
Real Estate Investors, the Leverage
Cycle,
and the Housing Market Crisis
Andrew Haughwout
Donghoon Lee
Joseph Tracy
Wilbert van der Klaauw
Staff Report no. 514
September 2011
This paper presents preliminary
findings and is being distributed to economists and other interested readers
solely to stimulate discussion and elicit comments.
The views expressed in this paper are
those of the authors and are not necessarily reflective of views at the Federal
Reserve Bank of New York or the Federal Reserve System. Any errors or omissions
are the responsibility of the authors.
Federal Reserve Bank of New York
Staff Reports
Real Estate Investors, the Leverage
Cycle,
and the Housing Market Crisis
Andrew Haughwout
Donghoon Lee
Joseph Tracy
Wilbert van der Klaauw
Staff Report no. 514
September 2011
This paper presents preliminary
findings and is being distributed to economists and other interested readers
solely to stimulate discussion and elicit comments.
The views expressed in this paper are
those of the authors and are not necessarily reflective of views at the Federal
Reserve Bank of New York or the Federal Reserve System. Any errors or omissions
are the responsibility of the authors.
Real
Estate Investors, the Leverage Cycle, and the Housing Market Crisis Andrew
Haughwout, Donghoon Lee, Joseph Tracy, and Wilbert van der Klaauw
Federal
Reserve Bank of New York Staff Reports, no. 514
September 2011
JEL classification: G21, D18, R31
Abstract
We explore a mostly undocumented but
important dimension of the housing market crisis: the role played by real
estate investors. Using unique credit-report data, we document large increases
in the share of purchases, and subsequently delinquencies, by real estate
investors. In states that experienced the largest housing booms and busts, at
the peak of the market almost half of purchase mortgage originations were
associated with investors.
In part by apparently misreporting
their intentions to occupy the property, investors took on more leverage,
contributing to higher rates of default. Our findings have important
implications for policies designed to address the consequences and recurrence
of housing market bubbles.
Key words: mortgages, leverage
Haughwout, Lee, Tracy, van der
Klaauw: Federal Reserve Bank of New York (e-mail: [email protected],
[email protected], [email protected],
[email protected]). The authors have benefited from helpful
comments and suggestions from participants at the April 2011 Housing Economics
and Research Conference at the University of California, Los Angeles, and the
2011 Society for Economic Dynamics Conference in Belgium. The views expressed
in this paper are those of the authors and do not necessarily reflect the
position of the Federal Reserve Bank of New York or the Federal Reserve System.
Real
Estate Investors, the Leverage Cycle, and the Housing Market Crisis Andrew
Haughwout, Donghoon Lee, Joseph Tracy, and Wilbert van der Klaauw
Federal
Reserve Bank of New York Staff Reports, no. 514
September 2011
JEL classification: G21, D18, R31
Abstract
We explore a mostly undocumented but
important dimension of the housing market crisis: the role played by real
estate investors. Using unique credit-report data, we document large increases
in the share of purchases, and subsequently delinquencies, by real estate
investors. In states that experienced the largest housing booms and busts, at
the peak of the market almost half of purchase mortgage originations were
associated with investors.
In part by apparently misreporting
their intentions to occupy the property, investors took on more leverage,
contributing to higher rates of default. Our findings have important
implications for policies designed to address the consequences and recurrence
of housing market bubbles.
Key words: mortgages, leverage
Haughwout, Lee, Tracy, van der
Klaauw: Federal Reserve Bank of New York (e-mail: [email protected],
[email protected], [email protected],
[email protected]). The authors have benefited from helpful
comments and suggestions from participants at the April 2011 Housing Economics
and Research Conference at the University of California, Los Angeles, and the
2011 Society for Economic Dynamics Conference in Belgium. The views expressed
in this paper are those of the authors and do not necessarily reflect the
position of the Federal Reserve Bank of New York or the Federal Reserve System.
The U.S. economy is still recovering
from the financial crisis that began in the fall of 2007.
The collapse of house prices across
many markets was a precipitating factor in the financial crisis and adverse
feedback effects between financial markets and the real economy led to the most
severe recession in the post-war period. Extraordinary interventions by fiscal
and monetary authorities both in the U.S. and abroad were required in order to
prevent a complete collapse of global markets and the potential onset of
another great depression.
Attention has shifted from containing
the financial crisis to examining its causes and designing policies to limit
both the likelihood and the severity of a similar crisis in the future. Given
the central role that housing played as a catalyst to the crisis, it is
important to better understand the determinants of the dynamics of house prices
and of subsequent mortgage defaults over this recent cycle. While house prices
were rising in many parts of the country over the period leading up to the
crisis, these increases were particularly pronounced in four states – Arizona,
California, Florida and Nevada (the “bubble” states). Figure 1 shows the path
of house prices in the US, the bubble states as a whole, and in each of these
states from 2000 Q1 to 2010 Q4.Over the period from 2000 to 2006
average house prices more than
doubled in each of these states. The pace of house price appreciation
accelerated starting in 2004. The peaks in prices across the four states
occurred within a couple of months of each other in mid-2006. Following the
turn in the markets, house prices declined rapidly in each state with much of
the earlier gains given back within just two years.2
This rapid run-up and then crash in
house prices exacted a terrible cost to homeowners, financial firms and to the
economy. Current estimates are that around 23 percent of active mortgages are
“under water” in that the balance on the mortgage exceeds the current value of
the 2 California is a bit of an exception in that it appears that average house
prices have stabilized at a level 50
percent higher than in 2000.
1
The U.S. economy is still recovering
from the financial crisis that began in the fall of 2007.
The collapse of house prices across
many markets was a precipitating factor in the financial crisis and adverse
feedback effects between financial markets and the real economy led to the most
severe recession in the post-war period. Extraordinary interventions by fiscal
and monetary authorities both in the U.S. and abroad were required in order to
prevent a complete collapse of global markets and the potential onset of another
great depression.
Attention has shifted from containing
the financial crisis to examining its causes and designing policies to limit
both the likelihood and the severity of a similar crisis in the future. Given
the central role that housing played as a catalyst to the crisis, it is
important to better understand the determinants of the dynamics of house prices
and of subsequent mortgage defaults over this recent cycle. While house prices
were rising in many parts of the country over the period leading up to the
crisis, these increases were particularly pronounced in four states – Arizona,
California, Florida and Nevada (the “bubble” states). Figure 1 shows the path
of house prices in the US, the bubble states as a whole, and in each of these
states from 2000 Q1 to 2010 Q4.Over the period from 2000 to 2006
average house prices more than
doubled in each of these states. The pace of house price appreciation
accelerated starting in 2004. The peaks in prices across the four states
occurred within a couple of months of each other in mid-2006. Following the
turn in the markets, house prices declined rapidly in each state with much of
the earlier gains given back within just two years.2
This rapid run-up and then crash in
house prices exacted a terrible cost to homeowners, financial firms and to the
economy. Current estimates are that around 23 percent of active mortgages are
“under water” in that the balance on the mortgage exceeds the current value of
the 2 California is a bit of an exception in that it appears that average house
prices have stabilized at a level 50
percent higher than in 2000.
1
house.3 As of 2010 Q4, nearly 2.8
million homes have gone through foreclosure, and another 2
million homes are in the process of
foreclosure.4 Serious delinquencies continue to add new homes to the
foreclosure pipeline over time. Nationally distress sales represent around half
of all repeat-sale transactions. These distress sales continue to exert
downward pressure on house prices making it more difficult for housing markets
to recover.
A focus on residential mortgage
finance in order to understand what the determinants were of the house price
and mortgage default dynamics generated over the recent cycle would inform
efforts to enhance financial stability. A more robust system of residential
mortgage finance should aim to limit the degree to which house prices rise and
fall over a credit cycle. Reducing the amplitude of the house price swings will
limit the potential for collateral damage created by housing markets for the
real economy.
Related
Literature
Given that housing is a durable
asset, periods of rising prices are indicative of increasing demand for
housing.5 One strand of the literature on housing demand focuses on the
determinants that affect the “user cost” of housing.6 The user cost of housing
( UC) is the annual flow cost to the
owner per dollar of house price, taking into account after-tax financing costs,
property taxes and insurance, maintenance and depreciation costs and the
expected risk-adjusted return to owning the house. The value of the housing
service flow is proxied by the annual rent ( R). If we assume that there is arbitrage between owned and rental housing,
then the annual rent should equate to the price of housing ( P) times the user-cost.
3
http://www.corelogic.com/About-Us/News/New-CoreLogic-Data-Shows-23-Percent-of-Borrowers-Underwater-with-$750-Billion-Dollars-of-Negative-Equity.aspx
4 http://www.ots.treas.gov/_files/490069.pdf
5 That is, with the exception of
natural disasters and periods of armed conflict, the supply of housing in a
market cannot contract significantly over a short period of time to drive up
house prices.
6 See Hendershott and Slemrod (1983)
and Poterba (1984) for early discussions.
2
house.3 As of 2010 Q4, nearly 2.8
million homes have gone through foreclosure, and another 2
million homes are in the process of
foreclosure.4 Serious delinquencies continue to add new homes to the
foreclosure pipeline over time. Nationally distress sales represent around half
of all repeat-sale transactions. These distress sales continue to exert
downward pressure on house prices making it more difficult for housing markets
to recover.
A focus on residential mortgage
finance in order to understand what the determinants were of the house price
and mortgage default dynamics generated over the recent cycle would inform
efforts to enhance financial stability. A more robust system of residential
mortgage finance should aim to limit the degree to which house prices rise and
fall over a credit cycle. Reducing the amplitude of the house price swings will
limit the potential for collateral damage created by housing markets for the
real economy.
Related
Literature
Given that housing is a durable
asset, periods of rising prices are indicative of increasing demand for
housing.5 One strand of the literature on housing demand focuses on the
determinants that affect the “user cost” of housing.6 The user cost of housing
( UC) is the annual flow cost to the
owner per dollar of house price, taking into account after-tax financing costs,
property taxes and insurance, maintenance and depreciation costs and the
expected risk-adjusted return to owning the house. The value of the housing
service flow is proxied by the annual rent ( R). If we assume that there is arbitrage between owned and rental
housing, then the annual rent should equate to the price of housing ( P) times the user-cost.
3
http://www.corelogic.com/About-Us/News/New-CoreLogic-Data-Shows-23-Percent-of-Borrowers-Underwater-with-$750-Billion-Dollars-of-Negative-Equity.aspx
4
http://www.ots.treas.gov/_files/490069.pdf
5 That is, with the exception of
natural disasters and periods of armed conflict, the supply of housing in a
market cannot contract significantly over a short period of time to drive up
house prices.
6 See Hendershott and Slemrod (1983)
and Poterba (1984) for early discussions.
2
