Illiquidity and its discontents: Trading delays and foreclosures in the housing market |
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| Institution: | 1. Haas School of Business, University of California, Finance 3001 Derby Street, Berkeley, CA 94705, United States;2. Bank of England, United Kingdom;3. Deliveroo, United Kingdom;4. Ernst & Young, United Kingdom;1. Macro-financial Division, Central Bank of Ireland, Ireland;2. Economic Analysis Division, Economic and Social Research Institute, Ireland;3. Department of Economics, Trinity College Dublin, Ireland |
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| Abstract: | The macroeconomic effects of housing illiquidity are analyzed using a novel directed search model of housing with long-term debt and default. Debt overhang emerges when highly leveraged sellers are forced to post high prices that produce long selling delays. These delays increase foreclosures, raise default premia, and curtail credit. Cheaper credit fuels temporarily higher house prices, faster sales, and fewer foreclosures, but the borrowing surge facilitates future debt overhang and default. More stringent foreclosure punishments also expand credit and, therefore, either generate higher foreclosures or more debt overhang. Leverage caps avoid this conundrum but reduce welfare by restricting borrowing. |
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| Keywords: | Housing Liquidity Search theory Mortgage debt Foreclosures |
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