%0 Journal Article
%T Dynamics of Housing Price: Foreclosure Rate Interactions
%A John F. McDonald
%A Houston H. Stokes
%J ISRN Economics
%D 2013
%R 10.1155/2013/250459
%X The dynamic impacts of the federal funds rate and the foreclosure rate on the log of the S&P/Case-Shiller aggregate 10-city monthly housing price index are investigated using VMA modeling techniques in the period 2000(1)¨C2011(3). The findings are consistent with the view that the interest rate policy of the Federal Reserve in that period that kept rates artificially low contributed to the housing bubble. Positive shocks in the foreclosure rate are shown to be associated with declines in the change in the housing price index after a lag. In addition, negative shocks in the change in the housing price index are associated with a higher foreclosure rate. The results suggest that both the change in the housing price index and the foreclosure rate create a negative externality that is dynamic. 1. Introduction Recent studies have documented the negative impact of foreclosures on housing prices. The most recent studies employ data that pertain to the period after the collapse of the housing price bubble in the US. As this paper is being written, the effects of the boom and bust of housing prices are still playing out over seven years after the peak in housing prices. The research strategy that has been followed in most of the previous studies is to examine the effect of nearby foreclosures in a recent prior time period on the selling prices of individual houses. However, most of these studies do not examine the effect of a decline in housing prices on foreclosure rates (An exception is the recent study by Capozza and Van Order [1], which finds that worsening economic conditions (i.e., declining house prices) are associated with much of the increase in mortgage defaults.). It is generally understood that a drop in the value of a house increases the incentive to default of the mortgage loan, especially if the fall in house value puts the owner ¡°under water.¡± The remaining balance on the loan is greater than the value of the house. A foreclosed house adds one more house to the supply of houses but does not increase demand since the credit rating of the prior owners is usually lower, limiting their demand in the housing market. The net effect is a further downward pressure on housing prices, usually with a lag. The basic hypothesis to be investigated in this paper is that house prices and foreclosure rates interact over time conditional on the log federal funds rate. The results of the study show that the housing market generates dynamic negative externalities that at this time seem to have no end point. An increase in foreclosures begets declines in house prices,
%U http://www.hindawi.com/journals/isrn.economics/2013/250459/