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)–2011(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,
References
[1]
D. R. Capozza and R. Van Order, “The great surge in mortgage defaults 2006–2009: the comparative roles of economic conditions, underwriting and moral hazard,” Journal of Housing Economics, vol. 20, no. 2, pp. 141–151, 2011.
[2]
J. F. McDonald and H. H. Stokes, “Monetary policy and the housing bubble,” Journal of Real Estate Finance and Economics, vol. 46, pp. 437–451, 2013.
[3]
M. Jarociński and F. R. Smets, “House prices and the stance of monetary policy,” Federal Reserve Bank of St. Louis Review, vol. 90, no. 4, pp. 339–365, 2008.
[4]
C. Vargas-Silva, “Monetary policy and the US housing market: a VAR analysis imposing sign restrictions,” Journal of Macroeconomics, vol. 30, no. 3, pp. 977–990, 2008.
[5]
T. Clauretie and G. Sirmans, Real Estate Finance, Cengage, Mason, Ohio, USA, 6th edition, 2010.
[6]
R. Green, A. B. Sanders, and S. Wachter, “Special issue on subprime mortgage lending,” Journal of Housing Economics, vol. 17, no. 4, p. 253, 2008.
[7]
A. B. Sanders and R. Van Order, “Introduction to the special issue on housing and the credit crunch,” Journal of Housing Economics, vol. 20, no. 2, pp. 66–67, 2011.
[8]
K. Vandell, “How ruthless is mortgage default? A review and synthesis of the evidence,” Journal of Housing Research, vol. 62, pp. 245–264, 1995.
[9]
M. LaCour-Little, “Mortgage termination risk: a review of the recent literature,” Journal of Real Estate Literature, vol. 16, no. 3, pp. 297–326, 2008.
[10]
Y. Deng, J. M. Quigley, and R. Van Order, “Mortgage terminations, heterogeneity and the exercise of mortgage options,” Econometrica, vol. 68, no. 2, pp. 275–307, 2000.
[11]
C. L. Foote, K. Gerardi, L. Goette, and P. S. Willen, “Just the facts: an initial analysis of subprime's role in the housing crisis,” Journal of Housing Economics, vol. 17, no. 4, pp. 291–305, 2008.
[12]
Y. Deng, A. D. Pavlov, and L. Yang, “Spatial heterogeneity in mortgage terminations by refinance, sale and default,” Real Estate Economics, vol. 33, no. 4, pp. 739–764, 2005.
[13]
Financial Crisis Inquiry Commission, The Financial Crisis Inquiry Report, Public Affairs, Perseus Books, New York, NY, USA, 2011.
[14]
C. deRitis, C. Kuo, and Y. Liang, “Payment shock and mortgage performance,” Journal of Housing Economics, vol. 19, no. 4, pp. 295–314, 2010.
[15]
W. R. Archer and B. C. Smith, “Residential mortgage default: the roles of house price volatility, euphoria and the borrower’s put option,” Journal of Real Estate Finance and Economics, vol. 46, pp. 355–378, 2013.
[16]
T. Clauretie and T. Herzog, “The effect of state foreclosure laws on loan losses: evidence from the mortgage insurance industry,” Journal of Money, Credit, and Banking, vol. 22, pp. 221–233, 1990.
[17]
J. Shilling, J. Benjamin, and C. F. Sirmans, “Estimating net realizable value for distressed real estate,” Journal of Real Estate Research, vol. 5, pp. 129–139, 1990.
[18]
F. Forgey, R. Rutherford, and M. VanBuskirk, “Effect of foreclosure status on residential selling price,” Journal of Real Estate Research, vol. 9, pp. 313–318, 1994.
[19]
W. Hardin and M. Wolverton, “The relationship between foreclosure status and apartment price,” Journal of Real Estate Research, vol. 12, pp. 101–109, 1996.
[20]
T. M. Springer, “Single-family housing transactions: seller motivations, price, and marketing time,” Journal of Real Estate Finance and Economics, vol. 13, no. 3, pp. 237–254, 1996.
[21]
T. Carroll, T. Clauretie, and H. Neill, “Effect of foreclosure status on residential selling price: comment,” Journal of Real Estate Research, vol. 13, pp. 95–102, 1997.
[22]
A. Pennington-Cross, “The value of foreclosed property,” Journal of Real Estate Research, vol. 28, no. 2, pp. 193–214, 2006.
[23]
T. M. Clauretie and N. Daneshvary, “Estimating the house foreclosure discount corrected for spatial price interdependence and endogeneity of marketing time,” Real Estate Economics, vol. 37, no. 1, pp. 43–67, 2009.
[24]
J. Y. Campbell, S. Giglio, and P. Pathak, “Forced sales and house prices,” American Economic Review, vol. 101, no. 5, pp. 2108–2131, 2011.
[25]
A. C. Goodman and B. C. Smith, “Residential mortgage default: theory works and so does policy,” Journal of Housing Economics, vol. 19, no. 4, pp. 280–294, 2010.
[26]
A. Mian, A. Sufi, and F. Trebbi, “Foreclosures, house prices, and the real economy,” Working Paper 16685, National Bureau of Economic Research, 2011.
[27]
N. Daneshvary, T. M. Clauretie, and A. Kader, “Short-term own-price and spillover effects of distressed residential properties: the case of a housing crash,” Journal of Real Estate Research, vol. 33, no. 2, pp. 179–208, 2011.
[28]
D. Immergluck and G. Smith, “The external costs of foreclosure: the impact of single-family mortgage foreclosures on property values,” Housing Policy Debate, vol. 17, no. 1, pp. 57–79, 2006.
[29]
Z. Lin, E. Rosenblatt, and V. W. Yao, “Spillover effects of foreclosures on neighborhood property values,” Journal of Real Estate Finance and Economics, vol. 38, no. 4, pp. 387–407, 2009.
[30]
J. Schuetz, V. Been, and I. G. Ellen, “Neighborhood effects of concentrated mortgage foreclosures,” Journal of Housing Economics, vol. 17, no. 4, pp. 306–319, 2008.
[31]
J. P. Harding, E. Rosenblatt, and V. W. Yao, “The contagion effect of foreclosed properties,” Journal of Urban Economics, vol. 66, no. 3, pp. 164–178, 2009.
[32]
T. Leonard and J. C. Murdoch, “The neighborhood effects of foreclosure,” Journal of Geographical Systems, vol. 11, no. 4, pp. 317–332, 2009.
[33]
W. H. Rogers and W. Winter, “The impact of foreclosures on neighboring housing sales,” Journal of Real Estate Research, vol. 31, no. 4, pp. 455–479, 2009.
[34]
R. Shiller, The Subprime Solution, Princeton University Press, Princeton, NJ, USA, 2009.
[35]
M. Zandi, Financial Shock, FT Press, Upper Saddle River, NJ, USA, 2009.
[36]
J. Hamilton, “On testing for self-fulfilling speculative price bubbles,” International Economic Review, vol. 27, pp. 545–552, 1986.
[37]
V. Mikhed and P. Zem？ík, “Testing for bubbles in housing markets: a panel data approach,” Journal of Real Estate Finance and Economics, vol. 38, no. 4, pp. 366–386, 2009.
[38]
A. C. Ghent and M. Kudlyak, “Recourse and residential mortgage default: evidence from US states,” Review of Financial Studies, vol. 24, no. 9, pp. 3139–3186, 2011.
[39]
A. Pennington-Cross, “The duration of foreclosures in the subprime mortgage market: a competing risks model with mixing,” Journal of Real Estate Finance and Economics, vol. 40, no. 2, pp. 109–129, 2010.
[40]
C. Granger, “Investigating causal relations by econometric models and cross-spectral models,” Econometrica, vol. 37, pp. 424–438, 1969.
[41]
W. Greene, Econometric Analysis, Pearson/Prentice Hall, Upper Saddle River, NJ, USA, 6th edition, 2008.
[42]
C. Sims, “Macroeconomics and reality,” Econometrica, vol. 48, pp. 1–49, 1980.
[43]
A. Zellner and F. Palm, “Time series analysis and simultaneous equation econometric models,” Journal of Econometrics, vol. 2, no. 1, pp. 17–54, 1974.
[44]
G. Box, G. Jenkins, and G. Reinsel, Time Series Analysis: Forecasting and Control, John Wiley & Sons, Hoboken, NJ, USA, 4th edition, 2008.
[45]
T. Doan, RatS USer’S Manual: VerSion 8.0, Evanston, Ill, USA, 2010.
[46]
H. Stokes, Specifying and Diagnostically Testing Econometric Models, Quorum Books, New York, NY, USA, 3rd edition, 2011.
[47]
T. Doan, Rats Reference Manual: Version 8.0, Evanston, Ill, USA, 2010.
[48]
W. Enders, Applied Econometric Time Series, John Wiley & Sons, Hoboken, NJ, USA, 2nd edition, 2004.
[49]
G. Gorton, Slapped by the Invisible Hand, Oxford University Press, New York, NY, USA, 2010.
