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1
The Impact of Low Income Home Owners on the Volatility of Housing Markets
Peter WesterheideZEW
European Real Estate Society Conference 2009Stockholm
June 26, 2009
2
Outline
Motivation
Literature Review
Data
Methodology
Empirical Results
Conclusions and Outlook
3
Motivation
Default of low income home owners (subprime borrowers) has
triggered the current crisis
Usual focus is on the behavior of lenders, not of borrowers
• Lending without properly checking creditworthiness
• „Originate and distribute“
Our Focus: What is the role of low income housing demand?
• Can we observe any destabilizing impact of low income
home ownership in the long run?
4
Motivation
Arguments in favor of destabilizing impact:
Low income households
• face a higher income risk of unemployment
• have low liquid wealth and often no buffer stock to
compensate income fluctuations
• are usually highly leveraged and have high interest/debt
burdens
• cannot rely on bailout by relatives
5
Motivation
Competing arguments: Low income households are
• less mobile (relative income position and regional location) ->
„trading up the ladder“ is less likely
• Wages are less variable than other components of income
therefore total income might be less variable
(as long as employed)
Net effect depends on institutional framework, might be different
in the housing cycle
Political target high home ownership rate: Is there a potential
tradeoff to the stability of housing markets?
Level and volatility of income are correlated
(Diaz-Serrano 2004, Dynan/Elmendorff/Sichel 2005,
Jensen/Shore 2008)
Extent of low income homeownership depends on completeness of mortgage markets (Chiuri/Japelli 2003, Bicacova/Siermienska 2007)
Income volatility and probability of mortgage default
6
Literature Review
Income Mortgage market
Housing prices
Housing demand
Financial leverage and volatility
Volatility of income in different income classes
Access to mortgage markets Structure of
demand and volatility of markets
Sensitivity of prices to income shocks depends on
leverage (Lamont/Stein 1999, Benito 2006)
Income volatility is related to mortage default (Diaz-Serrano 2004)
Low income homeowners increase price volatility (Ortalo-Magné/Rady 2002)Down payment constraints affect the stability of housing markets (Ortalo-Magné/Rady 2005)Volatility of house prices depends on tax wedges (van den Noord 2005)
7
Our approach
Direct analysis of impact of low income home ownership on
house price volatility in a cross country comparison
13 OECD countries, 1970-2006
Panel Regression with Fixed Effects
Pooled VAR
8
Data
Most important problem:
Data on distribution of home ownership and income
• No micro data for long time horizons
• Assumption of fixed distribution not realistic
• But: home ownership rate might be used
as a proxy for share of low income households
• Empirical evidence supports this assumption
9
Data
Rat
e of
Hom
e O
wne
rshi
p
Income
HHO Country
LHO Country
Stylized fact: home ownership rate and income distribution
10
DataRatio of home ownership 2nd/9th income decile and average home ownership rate
R 2 = 0.7267
0
1
2
3
4
5
6
0% 10% 20% 30% 40% 50% 60% 70%
Averag e H ome Owners hip R ate
Rati
o o
f Ho
meo
wn
ersh
ip R
ate
2nd
/9th
Inco
me
Dec
ile
GE
IT
US
FINUK
Own calculations, based on Bicacova /Siermienska (2007). Household head/spouse18-40 years old.
11
DataRatio of home ownership 3rd/9th income decile and average home ownership rate
R 2 = 0.8705
0
0.5
1
1.5
2
2.5
3
3.5
4
4.5
0% 10% 20% 30% 40% 50% 60% 70%
Averag e Home owners hip rate
Rati
o of
Hom
eow
ners
hip
Rat
e 3r
d/9t
h In
com
e D
ecile
UK
US
IT
FIN
GE
Own calculations, based on Bicacova /Siermienska (2007). Household head/spouse18-40 years old.
12
Data
Proxy Homeownership Rate
• No annual data (except UK and US)
• Survey based, 4 – 10 years
• Common definition: Share of owner occupied
dwellings in all dwellings
• Estimation of long term trends necessary
Assumption: high inertia
Short term fluctuations mainly reflect measurement error
13
Data
House Prices
• OECD Database, Girouard et al. 2006
• Heterogeneous data, focussing mostly on
used family homes
Other data OECD and UN, gaps filled by interpolation
based on national data:
• GDP per capita, long term interest rate, CPI, unemployment
rate, debt/GDP-ratio
14
Descriptive Evidence
R² = 0.3876
0.0
5.0
10.0
15.0
20.0
25.0
0.0% 2.0% 4.0% 6.0% 8.0% 10.0% 12.0%
Standard Deviation: Annual Percentage Change of Real House Prices
Inc
rea
se
of
Ow
ne
rsh
ip R
ati
o 1
97
0-2
00
6
(Pe
rce
nta
ge
Po
ints
)
UK
ES
IT
NL
FIN
IRL
SE
CH
CA
JP
FR
GE
US
15
Descriptive Evidence
FIN
ES
SE
JPCA
NL
US
GE
FR
CH
IRL
UKIT
R2 = 0.1857
0.0
10.0
20.0
30.0
40.0
50.0
60.0
70.0
80.0
90.0
0.0% 2.0% 4.0% 6.0% 8.0% 10.0% 12.0%
Standard Deviation of Annual Percentage Change of Real House Prices
Av
era
ge
Ow
ne
rsh
ip R
ati
o 1
97
0-2
00
6
(%)
16
MethodologyMultivariate Regression: Volatility of house prices
• Volatility of Real Income Growth (proxied by Real GDP per Capita)
• Unemployment rate
• Interest Rate
• Debt-to-GDP ratio
• House Price growth
• Volatility of Inflation Rate (CPI)
• Home ownership rate
Income
Credit Market
Prices
17
MethodologyTime Period 1970 – 2006
• Problem: Measure volatility in sub periods that are
long enough to show substantial variation…
• …but short enough to have sufficient data points in
the time series dimension
• Tests with several period lengths
• Finally: 11 overlapping periods of 7 years
18
Econometric ResultsResults of Regression for Nominal House Price Volatility
Dependent Variable: Volatility of Nominal House Prices
Coeff. Std. Error t-value P>|t|95 % confidence
interval
Volatility of CPI -0,026 0,214 -0,120,90
4 -0,450 0,398
Volatility of GDP 1,460 0,364 4,010,00
0 0,737 2,184
Interest Rate 0,709 0,309 2,290,02
4 0,095 1,322
Unemployment Rate -0,327 0,244 -1,340,18
3 -0, 81 0,156
Debt to GDP Ratio 0,041 0,034 1,200,23
4 0,026 0,108
Growth Rate of Nominal House Prices 0,261 0,081 3,20
0,002 0,099 0,422
Ownership ratio 0,780 0,344 2,270,02
5 0,098 1,463
Const. -0,005 0,005 -1,020,31
1 -0,016 0,005
R2 = 0,366
117 Observations (9 periods/13 countries)
Fixed effects regression, adjusted for serial correlation.
19
Econometric ResultsResults of Regression for Real House Price Volatility
Fixed effects regression, adjusted for serial correlation.
Dependent Variable; Volatility of Real House Prices
Coeff. Std. Error t-value P>|t|95 % confidence
interval
Volatility of CPI-
0,079 0,181 -0,440,66
3 -0,439 0,280
Volatility of GDP 1,896 0,321 5,910,00
0 1,259 2,532
Real Interest Rate 0,122 0,193 0,630,53
0 -0,261 0,505
Unemployment Rate-
0,194 0,216 -0,90,37
2 -0,623 0,235
Debt to GDP Ratio 0,052 0,027 1,930,05
7 0,002 0,105
Growth Rate of Real House Prices 0,174 0,067 2,62
0,010 0,042 0,306
Ownership ratio 0,504 0,278 1,820,07
2 0,046 1,057
Const.-
0,013 0,004 -3,280,00
1 -0,020 -0,005
R2 = 0,332
117 Observations (9 periods/13 countries)
20
MethodologySpecification of a VAR with annual values 1970-2006
• Are house prices more sensitive to shocks in HHO
vs. LHO countries?
• Variables: real house prices, real interest rates,
real GPD per capita, ownership ratio
• 2 lags
21
Econometric Results
0
0.5
1
1.5
2
2.5
3
3.5
4
1 2 3 4 5 6 7 8 9 10
GDP OR < 60
GDP OR >= 60
0
0.5
1
1.5
2
2.5
3
1 2 3 4 5 6 7 8 9 10
RHP OR < 60
RHP OR >= 60
-0.07
-0.06
-0.05
-0.04
-0.03
-0.02
-0.01
0
0.01
1 2 3 4 5 6 7 8 9 10
LI OR < 60
LI OR >=60
Reaction to House PricesReaction to GDP
Reaction to Interest Rates
22
ConclusionOwnership rate is proxy for share of low income home
owners
Some evidence for a positive correlation of home
ownership rate and volatility of house prices
Confirms theoretical findings
23
Outlook Inclusion of better credit market indicator (mortgage
market index)
Account for age structures/demographic structures
Test with US micro data for different regions?
Refine estimation of VAR
…
24
Thank you for your attention!!!
Contact:
Peter Westerheide
++49 621 1235 146
westerheide@zew.de
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