Working Paper No. 11-26 a Quantitative Analysis of the U.s. Housing and Mortgage Markets and the Foreclosure Crisis

We construct a quantitative equilibrium model of the housing sector that accounts for the homeownership rate, the average foreclosure rate, and the distribution of home-equity ratios across homeowners prior to the recent boom and bust in the housing market. We analyze the key mechanisms that account for these facts, including the preferential tax treatment of housing and inflation. We then use the model to gain a deeper understanding of the recent housing and mortgage crisis by studying the consequence of an unanticipated increase in the supply of housing (overbuilding shock). We show that the model can account for the observed decline in house prices and much of the increase in the foreclosure rate if two additional forces are taken into account: (i) the lengthening of the time to complete a foreclosure (during which a defaulter can stay rent-free in his house) and (ii) the tightening of credit constraints in the market for new mortgages.