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Lessons From The Great Recession:
Macro In The Shadow Of Wealth Hoarding
Atif Mian
University of California, Berkeley
Three broad hypotheses The “fundamentals” (credit demand) hypothesis
Leverage (and house prices) was driven by fundamentals, the economy got a bad unlucky shock leading to the recession
“House price increases largely reflect strong economic fundamentals …” - Oct. 20, 2005
The “excess credit” (credit supply) hypothesis
Supply curve for credit shifted out – credit supply became cheaper and more abundant. Why? Could be due to one or more of: securitization, agency problems, lose monetary policy, global imbalances etc.
The irrational exuberance in housing market hypothesis
People (irrationally) expected house prices to go up forever, and credit just followed these hyper-expectations.
Evidence Against Fundamentals View
Mian and Sufi QJE 2009
Areas with largest growth in credit have declining relative (and
absolute) incomes.
i.e. correlation of income and credit growth turned negative in 02-05.
Only period in last 20 years.
Inconsistent with standard demand side explanations
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Subprime and Prime zip codes are defined to be the highest and lowest quartile zip codes within each County based on the fraction of residentswith a credit score below 660 in 1991.
Credit Growth And Income Growth Over Time
Figure 3
Evidence in favor of supply expansion
Cross-sectional growth strongly correlated with growth
in non-GSE securitization and initial mortgage denial
rates.
Why supply expanstion?
Securitization? (financial innovation more broadly)
Yes
Loose monetary policy? (e.g. Taylor rule not followed)
However, low and declining interest rates not a sufficient explanation
Global imbalances?
Likely
Is Securitization To Blame?
The market imposed a strong credit supply constraint on
prospective borrowers in 1996, esp. subprime.
Growth in private securitization strongest in
sub-prime neighborhoods
Result driven by mortgages sold to “unrelated” parties!
Loose Monetary Policy? Sub-prime expansion did not happen in previous monetary expansion
Source: Mian and Sufi (2009)
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2001-2005
1990-1994
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(growth cumulative since Year0)
Subprime and Prime zip codes are defined to be the highest and lowest quartile zip codes within each County based on the fraction of residentswith a credit score below 660 in the base year.
Relative Mortgage Origination Growth For Subprime Zip CodesIn Falling Interest Rate Periods
Figure 4
Global Imbalances?
Securitization may be a “proximate cause” of sub-prime
credit expansion and house price appreciation
But securitization has been around for years
Why did it jump up all of a sudden around 2001-02?
A “deeper cause” of the rise in securitization and hence the housing
bubble is likely to be related to “global imbalances”
Global imbalances
Fast-growing and oil-rich Asian economies start saving large amounts
of capital (primarily through their central banks)
This capital is pushed into western countries … primarily the U.S.
Why did Asia do that?
We need to get understand a bit of history to appreciate the full
backdrop. [See Appendix Slides: Will cover time-permitting]
House price appreciation expectations?
There are two Americas
Flat America (Atlanta)
Rocky / coastal America (San Francisco)
Flat America has high housing supply elasticity
Any house price appreciation pressure leads to more housing
that can be easily built
House prices are not expected to go up (Caveat: no one understands Nevada!!)
Hence, is house price appreciation created the sub-prime
boom, we should not observe it in Flat America (e.g.
Texas, Atlanta)
But we do! (Source: Mian and Sufi 2009)
Marginal Propensity to Consume (MPC) declines with Permanent Income
Financial shocks in the presence of leverage redistribute resources from net borrowers (low wealth) to net lenders (high wealth)
Heterogeneity in MPC implies financial shocks translate into aggregate real shocks.
We do not need a banking sector to amplify shocks here.
These effects are purely driven by “aggregate demand” fluctuations
Also gives us “liquidity trap”
Implications …
U.S. HH Debt to GDP: 1916-today
Is it just a coincidence?
Consistent with the speculative theory I presented
more evidence ….
What can be done about HH debt?
Monitor / Regulate HH leverage?
But who decides what level is appropriate?
Who announces “the party is over”?
Past experience not very promising (U.S., Europe, Japan)
Better to see the problem as one primarily of efficient risk sharing.
We may not know when households have over-borrowed
But we can design mortgage contracts such that if a systemic shock were to occur, risk (losses) will be distributed between borrowers and lenders more evenly.
e.g. linking mortgage principal write downs (ex-ante) to aggregate (or regional) house price indices.
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