How Do Foreclosures Exacerbate Housing Downturns?

45 Pages Posted: 3 Sep 2019

See all articles by Adam M. Guren

Adam M. Guren

Boston University - Department of Economics

Timothy McQuade

Stanford University

Date Written: August 2019

Abstract

This paper uses a structural model to show that foreclosures played a crucial role in exacerbating the recent housing bust and to analyze 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 percent of the total decline in non-distressed prices and lender losses account for an additional 22.6 percent. 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.

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Suggested Citation

Guren, Adam M. and McQuade, Timothy, How Do Foreclosures Exacerbate Housing Downturns? (August 2019). NBER Working Paper No. w26216. Available at SSRN: https://ssrn.com/abstract=3446526

Adam M. Guren (Contact Author)

Boston University - Department of Economics ( email )

270 Bay State Road
Boston, MA 02215
United States

HOME PAGE: http://people.bu.edu/guren/

Timothy McQuade

Stanford University ( email )

Stanford, CA 94305
United States

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