If Prices Fall, Mortgage Foreclosures Will Rise

In our previous post, we illustrated the recent extraordinarily strong growth in home prices and explored some of its key spatial patterns. Such price increases remind many of the first decade of the 2000s when home prices reversed, contributing to a broad housing market collapse that led to a wave of foreclosures, a financial crisis, and a prolonged recession. This post explores the risk that such an event could recur if home prices go into reverse now. We find that although the situation looks superficially similar to the brink of the last crisis, there are important differences that are likely to mitigate the risks emanating from the housing sector.

Same Old Story?

Our last post demonstrated that price increases have been unusually strong and are now at rates not seen since just prior to their peak in 2005 at 16 percent year-over-year. Prices then fell 20 percent between mid-2006 and early 2009. By 2012 the average home had lost about a quarter of its 2006 value. Because prices had risen and fallen so fast, new mortgage originations in the period leading up to the peak, including those with substantial down payments, were quickly put into negative equity, which is a major risk factor for foreclosure, as both academic research and the experience of 2007-11 demonstrate.

Are developments in the housing market now essentially the same? Well prices have certainly been rising very fast, and mortgage originations have also been strong. The former, however, has outpaced the latter in recent months. Additionally, the owner’s share of housing wealth is 67 percent as of the first quarter of 2021, its highest value since 1989. (This is the value of the property minus the debt owed on it, expressed as a share of the property value.) Note that during the previous housing boom (1995-2006) this measure didn’t rise, in spite of sharply rising home prices. Additional borrowing was large enough to keep the owner’s share roughly constant at about 61 percent.

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