Media Briefings

Credit Standards And Household Expectations: Making Sense Of The Boom And Bust In US House Prices

  • Published Date: May 2011


A loosening and tightening of mortgage credit standards drove the US house price boom
and bust of the 2000s. New research by John Duca, John Muellbauer and Anthony
Murphy
, published in the May 2011 issue of the Economic Journal, shows how the US
housing market was initially driven up by an unsustainable easing in mortgage credit
standards which fed into households’ unrealistic expectations of capital gains, and then
driven down as lending practices and expectations corrected.
The analysis indicates that the first time homebuyer tax credit did temporarily help to slow
down the fall in US house prices in 2009. And the researchers’ latest results suggest that
while one widely used measure of average US house prices may fall a little further in 2011,
the housing market is likely to recover slowly from 2012 onwards.
After the recent US house price boom and bust, there are two big questions. First, can
conventional economic models explain what happened? And second, when will average US
house prices reach bottom and start drifting up?
This study by researchers at the Federal Reserve Bank of Dallas and Oxford University
concludes that standard models, which failed to take account of the relaxation of mortgage
credit standards, break down in the early 2000s.
Using data from the American Housing Survey, they show that this relaxation of standards
was reflected in a fall in the typical down-payment ratio for a first-time buyer from 12% in
the mid-1990s to about 6% at the height of the subprime boom.
The subsequent tightening of credit standards and the correction of unrealistic expectations
drove house prices down after 2006. The research also suggests that average US house
prices should stabilise by early 2012.
The researchers’ measure of mortgage credit standards is statistically highly significant in a
model of the average US house price-to-rent ratio. The model also includes a measure of
the ‘user cost of housing’, which incorporates the mortgage interest rate and the costs both
of tax and of buying and selling minus the expected capital gain or loss from future changes
in house prices.
The study indicates that most housing market participants base their expectations of capital
gains on past gains. This can lead to the kind of overshooting of house prices seen in the
mid-2000s, when after years of house price rises driven by easy credit and low interest
rates, people became over-confident about further rises.
The researchers obtain stable and sensible models that explain US house prices since
1981. They also find that the first time homebuyer tax credit did temporarily help to slow
down the fall in US house prices in 2009. Their model correctly forecast half a year in
advance that house prices would start falling again after the tax credit was withdrawn in
May 2010.
In more recent work, which uses an alternative model of US house prices based on supply
and demand, the researchers examine scenarios for future US house prices assuming that
mortgage credit standards remain at their 2009 level (similar to their level in 2002) and the
economy grows in line with publicly available consensus forecasts.
Figure 1: House prices likely to bottom out in early 2012
Source: Freddie Mac conventional mortgage house price index (purchase only transactions) and authors' calculations.
The results suggest that a widely used measure of average US house prices may fall a little
further in 2011, but is likely to bottom out and recover slowly from 2012 onwards (see
Figure 1). The simulations are based on projections of incomes and policy developments
that are hard to predict, as is the impact of sales of properties in foreclosure.
The researchers conclude that although different regions will bottom and recover at
different times, if the simulations for the average are correct, the drag on the US economy
from the housing market should ebb in 2012.
ENDS
Notes for editors: ‘House Prices and Credit Constraints: Making Sense of the US
Experience’ by John Duca, John Muellbauer and Anthony Murphy is published in the May
2011 issue of the Economic Journal.
The researchers’ latest work is reported in ‘Shifting Credit Standards and the Boom and
Bust in US House Prices’ by John Duca, John Muellbauer and Anthony Murphy, a Federal
Reserve Bank of Dallas working paper published in 2011.
John Duca is at the Federal Reserve Bank of Dallas and Southern Methodist University.
John Muellbauer is at Nuffield College, Oxford and the Oxford Martin School. Anthony
Murphy is in the research department of the Federal Reserve Bank of Dallas.
The views expressed are those of the authors and do not necessarily reflect those of the
Federal Reserve Bank of Dallas or the Board of Governors of the Federal Reserve System.
For further information: contact Anthony Murphy on +1 214-922-5230 (email:
anthony.murphy@dal.frb.org); or Romesh Vaitilingam on +44 7768-661095 (email:
romesh@vaitilingam.com).