Housing Finance and the Boom-Bust in the U . S . Housing Market ∗

This paper analyzes the role of the housing finance during the 2000s housing boombust in the U.S. using a quantitative macroeconomic model with housing market search frictions and long-term mortgages with default option. In the model, the housing boom is fueled by easy credit conditions in the mortgage market that generate sizable increases in homeownership, refinancing activity, but modest effects on aggregate consumption. While the form of housing finance (adjustable rate vs. fixed rate mortgages) is not very important during the housing boom, it matters for the speed of the recovery. When borrowers use ARMs, their consumption during bust periods is more sensitive to changes in the interest rate. The model also rationalizes the asymmetric behavior of consumption—namely, that it is more sensitive to house price declines than increases.