Housing Finance, Boom-Bust Episodes, and Macroeconomic Fragility

Using an equilibrium macro-housing model with incomplete markets, defaultable mortgage debt, and endogenous liquidity, this paper analyzes how institutional details of the housing finance system impact macroeconomic fragility and the magnitude of boom-bust episodes. With a focus on the recent U.S. experience, the post-2000 decline in mortgage rates emerges as the most powerful driver of the boom in house prices and consumption. Mortgage design also has first-order effects on aggregate and cross-sectional behavior by altering households’ exposure to interest rate risk, rollover risk, and liquidity risk. Consistent with empirical evidence, highly leveraged homeowners contribute disproportionately to the response of aggregate dynamics to different contract features. Macroprudential policies reduce high-risk borrowing but also limit insurance opportunities, resulting in ambiguous changes to economic fragility.