Monday, January 12, 2015

Sub-priming the well...and its aftermath

As a follow up to the prior post on the FHA's intention to further assist low down payment home lending, has two posts reminding us of the consequences of last time. First, from Berkeley grad student John Mondragon, who exploited data from a bank, Wachovia, that suffered many bad loans;
Wachovia’s origination behaviour was average leading up to the Crisis, but during the Crisis Wachovia was significantly less likely to originate a loan, especially for low- and middle-income applicants.
Because of this contraction, counties exposed to Wachovia experienced larger declines in the flow of household credit. This resulted in lower house prices, house sales, and non-housing expenditures. Using exposure to Wachovia as an instrument for the flow of household credit, I estimate the causal effect of supply-driven declines in household credit on employment.
  • I find that a 10% reduction in the flow of non-refinance mortgages from 2007-2010 reduced employment by 3%, driven entirely by losses in construction and non-tradeables.
 Then come two English economists, Philip Bunn and May Rostom, to show essentially the same thing in the UK;
A major development in UK household balance sheets in the decade before the Financial Crisis was the build-up of household debt. By 2008, household debt had risen to 160% of income from around 100% a decade earlier (Figure 1), mostly accounted for by increases in mortgage debts.
As in the U.S;
Using microdata from the Living Costs & Food (LCF) Survey, we find a similar pattern for the UK of more indebted households making larger cuts in spending during the Financial Crisis.1 Figure 2 shows that households with mortgage debt to income ratios greater than 2 are estimated to have made larger-than-average reductions in spending relative to income after 2007.2 Disaggregating the data for mortgagors further, the largest adjustment in spending relative to income came, perhaps not surprisingly, among households with a mortgage debt to income ratio above 4  ....
And conclude;
[The] microdata evidence shows that highly indebted UK households made larger-than-average cuts in spending relative to income after 2007, although this only represents an unwinding of faster-than-average spending growth by this group before the Crisis. This work adds to the growing body of international evidence which suggests that high levels of household indebtedness helped to increase the depth of the Great Recession.
Bold by HSIB.

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