Keynesian Spirits

Role of Household Leverage in 2007 Recession

Below is the summary of a summary – the highly illuminating and rigourous work of Atif Mian (Berkeley) and Amir Sufi (Chicago) on the intersection of finance and macroeconomics, specifically on how household leverage influenced real economic outcomes:

1. From 2001 to 2007, household debt doubled, from $7 trillion to $14 trillion. The household debt-to-income ratio increased by more during these six years than it had in the prior 45 years. The household debt-to-income ratio in 2007 was higher than at any point since 1929.

2. Mortgage-related debt makes up 70 to 75 percent of household debt and was primarily responsible for the overall increase in household debt. The expansion of new mortgage originations was much larger in zip codes with a large fraction of low credit-quality households.

3. The fraction of home purchase mortgages that were securitized by non-GSE (government sponsored enterprise) institutions rose from 3 percent to almost 20 percent from 2002 to 2005. Non-GSE securitization primarily targeted zip codes that had a large share of subprime borrowers. In these zip codes, mortgage denial rates dropped dramatically and debt-to-income ratios skyrocketed. Expansion in mortgage credit did not reflect productivity or permanent income improvements for marginal borrowers.

4. The expansion in mortgage credit was more likely to be a driver of house price growth than a response to it.

5. From 2007 to 2009, foreclosures were responsible for 20 to 30 percent of the decline in house prices, 15 to 25 percent of the decline in residential investment, and 20 to 35 percent of the decline in auto sales.

6. Special interest pressure via campaign contributions from the financial industry influenced voting behavior on the financial rescue legislation that was designed to provide support to the banking sector in 2008. Similarly, constituent pressure from delinquent and under-water homeowners significantly influenced legislators to vote in favor of legislation that promoted mortgage modifications.


NBER Research Summary


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