bond markets calibrated to match the increase in foreign ownership of U.S. Treasury and agency debt from 2000-2007 generates an increase in national price-rent ratios comparable to that observed in U.S. data over this period. Moreover, in a simulated transition for the period 2000-2009, the model generates a decline of greater than 16% in national house price-rent ratios in the two year period 2007 to 2009, driven by the economic contraction and by a presumed reversal of the financial market liberalization. A financial market liberalization drives risk premia in both the housing and equity market down, shifts the composition of wealth for all age and income groups towards housing, and leads to a short-run boom in aggregate consumption but a short-run bust in investment. By contrast, although an influx of foreign capital into the domestic bond market reduces interest rates, it increases risk premia in both the housing and equity markets. Finally, the model implies that procyclical increases in equilibrium price-rent ratios reflect expectations of lower future housing returns, not higher future rents.

The Macroeconomic E¤ects of Housing Wealth, Housing Finance, and Limited Risk-Sharing in General Equilibrium

https://surface.syr.edu/cgi/viewcontent.cgi?article=1114&context=cpr

Nominal Loss Aversion, Housing Equity Constraints, and Household Mobility: Evidence from the United States

The present crisis is the bottom of a recurring problem that I call the leverage cycle, in which leverage gradually rises too high then suddenly falls much too low. The government must manage the leverage cycle in normal times by monitoring and regulating leverage to keep it from getting too high. In the crisis stage the government must stem the scary bad news that brought on the crisis, which often will entail coordinated write downs of principal; it must restore sane leverage by going around the banks and lending at lower collateral rates (not lower interest rates), and when necessary it must inject optimistic capital into firms and markets than cannot be allowed to fail. Economists and the Fed have for too long focused on interest rates and ignored collateral.

/pdf/solving-the-present-crisis-and-managing-the-leverage-cycle-29zfuw9t10.pdf

Solving the Present Crisis and Managing the Leverage Cycle

The confluence of three trends in the U.S. residential housing market - rising home prices, declining interest rates, and near-frictionless refinancing opportunities - led to vastly increased systemic risk in the financial system. Individually, each of these trends is benign, but when they occur simultaneously, as they did over the past decade, they impose an unintentional synchronization of homeowner leverage. This synchronization, coupled with the indivisibility of residential real estate that prevents homeowners from deleveraging when property values decline and homeowner equity deteriorates, conspire to create a “ratchet” effect in which homeowner leverage is maintained or increased during good times without the ability to decrease leverage during bad times. If refinancing-facilitated homeowner-equity extraction is sufficiently widespread - as it was during the years leading up to the peak of the U.S. residential real-estate market - the inadvertent coordination of leverage during a market rise implies higher correlation of defaults during a market drop. To measure the systemic impact of this ratchet effect, we simulate the U.S. housing market with and without equity extractions, and estimate the losses absorbed by mortgage lenders by valuing the embedded put-option in non-recourse mortgages. Our simulations generate loss estimates of $1.5 trillion from June 2006 to December 2008 under historical market conditions, compared to simulated losses of $280 billion in the absence of equity extractions.

/pdf/systemic-risk-and-the-refinancing-ratchet-effect-rewz6scllf.pdf

Systemic Risk and the Refinancing Ratchet Effect

Although nonprime lending has experienced steady or even explosive growth over the last decade very little is known about the performance characteristics of these mortgages. Using data from national secondary market institutions, this paper estimates a competing risks proportional hazard model, which includes unobserved heterogeneity. The analysis examines the performance of 30-year fixed rate owner occupied home purchase mortgages from February 1995 to the end of 1999 and compares nonprime and prime loan default and prepayment behavior. Nonprime loans are identified by mortgage interest rates that are substantially higher than the prevailing prime rate. Results indicate that nonprime mortgages differ significantly from prime mortgages: they have different risk characteristics at origination; they default at elevated levels; and they respond differently to the incentives to prepay and default. For instance, nonprime mortgages are less responsive to how much the option to call the mortgage or refinance is in the money and this effect is magnified for mortgages with low credit scores. Tests also reveal that default rates are less responsive to homeowner equity when credit scores are included in the specification.

/pdf/credit-history-and-the-performance-of-prime-and-nonprime-3et5q4sbch.pdf

Credit History and the Performance of Prime and Nonprime Mortgages

Homeowners typically have the option to prepay all or part of the outstanding balance of their mortgage loan at any time, usually without penalty. However, unless homeowners have sufficient wealth to pay off the balance, they must obtain a new loan in order to exercise this option. Studies examining refinancing behavior are finding more and more evidence that differences in homeowners' ability to qualify for new mortgage credit, as well as differences in the cost of that credit, account for a significant part of the observed variation in that behavior. Therefore, individual homeowner and property characteristics, such as personal credit ratings and changes in home equity, must be considered systematically, along with changes in mortgage interest rates, in the analysis and prediction of mortgage prepayments. Early research into the factors influencing prepayments focused almost exclusively on the difference between the interest rate on a homeowner's existing mortgage and the rates available on new loans. This approach arose in part because researchers most often had to rely on aggregate data on the pools of mortgages serving as the underlying collateral for mortgage-backed securities (for example, see Schorin {1992}). More recent research, however, has broadened the scope of this investigation through the utilization of loan-level data sets that include individual property, loan, and borrower characteristics. This article significantly advances the literature on mortgage prepayments by introducing quantitative measures of individual homeowner credit histories to the loan-level analysis of the factors influencing the probability that a homeowner will refinance. In addition to credit histories, we include in the analysis changes in individual homeowner's equity and in the overall lending environment. Our findings strongly support the hypothesis that, other things being equal, the worse a homeowner's credit rating, the lower the probability that he or she will refinance. We also confirm the finding of other researchers that changes in home equity strongly influence the probability of refinancing. Finally, we provide evidence of a change in the lending environment that, all else being equal, has increased the probability that a homeowner will refinance. These findings are important from an investment risk management perspective because they confirm that the responsiveness of mortgage cash flows to changes in interest rates will also be significantly influenced by the credit and equity conditions of individual borrowers. Moreover, evidence overwhelmingly indicates that these conditions are subject to dramatic changes. For example, although the sharp rise in personal bankruptcies since the mid-1980s (Chart 1) partly reflects changes in laws and attitudes, it nonetheless suggests that credit histories for a growing segment of the population are deteriorating. Furthermore, home price movements, the key determinant of changes in homeowners' equity, have differed considerably over time and in various regions of the country. Indeed, in the early to mid-1990s home price appreciation for the United States as a whole slowed dramatically while home prices actually fell for sustained periods in a few regions (Chart 2). [Chart 1-2 ILLUSTRATION OMITTED] In short, as mortgage rates fell during the first half of the 1990s, many households likely found it difficult, if not impossible, to refinance existing mortgages because of poor credit ratings or erosion of home equity.(1) Consequently, the prepayment experience of otherwise similar pools of mortgage loans may vary greatly depending on the pools' proportions of credit- and/or equity-constrained borrowers. Our findings also contribute to an understanding of how constraints on credit availability affect the transmission of monetary policy to the economy (for example, see Bernanke {1993}). Fazzari, Hubbard, and Petersen (1988) and others have found that investment expenditures by credit-constrained businesses are especially closely tied to those firms' cash flows and are relatively insensitive to changes in interest rates, reflecting constraints on their ability to obtain credit. …

/pdf/credit-equity-and-mortgage-refinancings-148zruueal.pdf

Credit, Equity, and Mortgage Refinancings

Using a unique loan level data set that links individual household credit ratings with property and loan characteristics, we test the extent to which homeowners' equity and credit ratings affect the likelihood that mortgage loans will be refinanced as interest rates fall. The logit model estimates strongly support the importance of both the equity and credit ratings affect the likelihood that mortgage loans will be refinanced as interest rates fall. The logit model estimates strongly support the importance of both the equity and credit variable. These results are interesting both from the viewpoint of investors in mortgage products (since prepayments are directly affected) and from the perspective of monetary policy (since refinancings are one channel by which lower interest rates normally help reliquify households).

Jonathan Raiff

Papers

Credit, Equity, and Mortgage Refinancings

Effects of Household Creditworthiness on Mortage Refinancings

Effects of household creditworthiness on mortgage refinancings