Susan Wachter and I have a new paper out, entitled Why Housing? The paper is a critical review of scholarly theories of the housing bubble. It focuses on the question of what made housing vulnerable to a bubble and why it has been so hard to resuscitate the market.
The article also lays out in concise form the theory of the bubble that Susan and I have been propounding for a while namely that the key to understanding the bubble is the shift in the financing channel from Agency securitization to private-label securitization, an asset class rich in information and agency problems. Our short version of the bubble is that financial intermediaries exploited private-label securitization's information problems to inflate a bubble that produced short-term gains for them through fee-based income. In other words, this was a man-made bubble, not the product of government affordable housing policy, macroeconomic policy, irrational exuberance, or ineluctable forces of supply and demand. The abstract is below the break.
What
made housing vulnerable to a bubble? And
why has the housing market been so impervious to attempts at
resuscitation?
This
Article critically reviews the theories of the housing bubble. It argues that
housing is unusually susceptible to booms and busts because credit conditions
affect demand and because the market is incomplete and difficult to short.
Housing market distress transmits to the macroeconomy through a balance sheet
channel, a construction channel, and a collateral channel.
Housing
is unique as an asset class in that it is both a consumption and investment
good. It is also the largest single
consumer asset and debt class. Because
housing is credit-backed and such a large asset class, failure will impact the
financial system itself and pull down the economy as a whole. The dual-use of
housing, its ubiquity on consumer balance sheets, its highly correlated
pricing, and its linkage to the macroeconomy make it a particularly painful
type of asset bubble to deflate.
The credit-backed
nature of housing is also the key to understanding why there was a bubble. We argue that the bubble must be understood
as stemming from the change in the mortgage financing channel from Agency
securitization to private-label securitization (PLS). This shift enabled financial
intermediaries—economic, but not legal agents of borrowers and investors—to
exploit the information problems inherent in PLS for their own short-term
gain. In other words, a set of agency
problems in financial intermediation was the critical factor in fomenting the
housing bubble.
