NCPA - National Center for Policy Analysis

Housing Bust Accounts For the Slow Economic Recovery

April 1, 2015

Purchasing assets with borrowed money can amplify small movements in prices into extraordinary gains, crippling losses or even default.

Bank lending in advanced economies quadrupled in the second half of the 20th century, from about 30 percent of GDP in 1945 to about 120 percent of GDP just before the 2008 global financial crisis. The sharp increase has primarily resulted from the rapid growth of loans secured by real estate.

Household mortgage debt appears to have risen faster than total real estate asset values in the United States. The ratio of household mortgage lending to the value of the total U.S. housing stock has nearly quadrupled from about 0.15 in 1910 to about 0.5 today. The resulting record-high leverage ratios can damage household balance sheets and therefore endanger the overall financial system.

In the United States, Large-scale government interventions into housing markets developed after the Great Depression. Although much of this legislation was explicitly designed to control high-risk finance, other policies made basic forms of finance more accessible to the public. Aided by such policies, American homeownership increased from 40 percent in the 1930s to nearly 70 percent by 2005.

A mortgage boom gone bust is typically followed by rapid household deleveraging, which tends to depress overall demand as borrowers shift away from consumption toward saving. This has been one of the most visible features of the slow United States' recovery from the global financial crisis.

The explosion of credit has played a more important role in shaping the business cycle than has been appreciated up to now. Much of the recent expansion in bank lending took place through real estate lending, and this particular component of the credit mix appears to have the most relevant macroeconomic effects.

Source: Òscar Jordà, Moritz Schularick, Alan M. Taylor, "Mortgaging the Future?" Federal Reserve Bank of San Francisco Economic Letter, March 23, 2015.


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