Abstract

Property markets have always been cyclical, and many economists have explored
the causes and consequences of cyclicality in housing and commercial real estate.
Indeed, for more than a half century after the great depression, the National Bureau
of Economic Research (NBER) regularly explored linkages among real estate investment, mortgage credit, and aggregate business cycles (see, e.g., NBER volumes by Wickens and Foster 1937; Blank 1954; Abramovitz 1964; Zarnowitz 1992). The
regular boom and bust cycles in real property were important in their own right,
but also as key components of the aggregate business cycle.
In previous work we have analyzed the way housing booms at the top of the
business cycle tend to unwind, relying upon the experience of the USA over the
past 35 years (Case and Quigley 2008). In that analysis we sought to emphasize
the unique aspects of housing markets that contributed to the end of the boom in
the US economy in the twenty-first century.

But by 2008, however, the decline in the US housing and mortgage markets had
moved far beyond the unwinding of a traditional and well-understood housing boom.
We are in the midst of an unprecedented decline. Housing starts and existing sales
are at record low levels, and the huge US mortgage market has collapsed in a sea
of defaults and foreclosures, sending shock waves through the world financial
system. Trillions of dollars in what were thought to be “safe” fixed-income investments have been wiped out in a short period of time.
Now the questions are: When and how will the current severe decline be
arrested? When will the market return to some sense of normalcy? How far will
prices decline? How large will financial losses be? Who will ultimately bear those
losses? What can we do to avoid a disaster like this in the future?
This paper does not pretend to answer all of those questions, but instead to provide a framework emphasizing the economic factors that will ultimately determine those answers.

Our focus will be on the housing market and home prices. The second section
presents a quantitative history of the movement of home prices in the USA
between 1975 and 2008, including the impact of the boom-and-bust cycle of
2000–2008 on the national balance sheet, as well as the historical relationship between
home prices and household income over the cycle.
We then go on to describe the traditional process of disequilibrium adjustment
which is unique to the housing market, and which has played itself out during every
previous recovery period. This housing bust of 2005–2008, however, is different
in a variety of ways which make the task of predicting the timing and the character
of the ultimate bottom more difficult.

The following section presents a perspective that helps integrate the effects of the
important, but seemingly disparate, aspects of the current housing crisis in the USA.
These aspects include home price changes, expectations about price changes, the
demand for housing, and the diffusion of relaxed mortgage underwriting standards
in the USA during the period leading up to the crash in the housing market. This
perspective is the annual user-cost of housing capital – which drives the demand
for housing and homeownership, the demand for housing finance, and the demand
for liquidity in the housing market. This perspective also reconciles the demand for
relaxed standards of mortgage finance and the profitability of those alternative
mortgages to financial institutions. The final section is a brief conclusion.

Download File

Download a PDF (298KB)