Liquidity Constraints in the U.S. Housing Market

Abstract

We study the severity of liquidity constraints in the U.S. housing market using a life-cycle model with uninsurable idiosyncratic risks in which houses are illiquid, but agents can extract home equity by refinancing their mortgages. The model implies that four-fifths of homeowners are liquidity constrained and willing to pay an average of 13 cents to extract an additional dollar of liquidity from their home. Most homeowners value liquidity for precautionary reasons, anticipating the possibility of income declines and the need to make mortgage payments. The model reproduces well the observed response of consumption to tax rebates and mortgage relief programs and predicts large welfare gains from policies aimed at providing temporary liquidity relief to homeowners.