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Cambridge MA. -- Contrary to the assertions of many economists and others, the boom and bust in housing over the last decade was not primarily caused by low interest rates, reduced downpayment requirements, or laxer underwriting standards, conclude Edward Glaeser, Joshua Gottlieb, and Joseph Gyourko in “Did Credit Market Policies Cause the Housing Bubble?” a new Policy Brief published by the Rappaport Institute for Greater Boston and the Taubman Center for State and Local Government at the John F. Kennedy School of Government at Harvard University.
The paper was released on Wednesday, May 5 at a conference on “Understanding the Housing Collapse: What is to Blame and What Can Be Done?” at the Federal Reserve Bank of Boston cosponsored by the Institute, the Center, the bank’s New England Public Policy Center, and the bank’s research department. “It isn’t that low interest rates don’t boost housing prices. They do,” write Glaeser, a professor of economics who directs the Rappaport Institute and the Taubman Center, and his colleagues, Joshua Gottlieb, a doctoral student in economics at Harvard; and Joseph Gyourko, a professor of real estate at the Wharton School.
“It isn’t that higher mortgage approval rates aren’t associated with rising home values. They are,” they add. “But the impact of these variables, as predicted by economic theory and as estimated empirically over many years, is too small to explain much of the housing market event that we have just experienced.” Specifically, the authors found that the 1.3 percentage point drop in real interest rates between 2000 and 2006 was responsible for only a 10 percent rise in prices, about a third of the average price increases nationally during that time and even a smaller share of the increase in many metropolitan areas, including greater Boston, where prices rose by 54 percent between 2000 and 2006.
Glaeser, Gottlieb and Gyourko did find that the price effect of interest rates was greatest in metropolitan areas such as Boston, San Francisco, New York, and Seattle that have less land, more regulation and/or topography that is not conducive to new buildings. However, that impact was not enough to explain the full magnitude of the housing bubble in those places. They estimate, for example, that reduced interest rates should have caused prices in greater Boston to rise by about 14 percent between 2000 and 2006, significantly less than the actual increase of 54 percent.
The authors also found that contrary to the assertions of many analysts, including Benjamin Bernanke, chairman of the Board of Governors of the Federal Reserve System, reduced downpayment requirements did not greatly contribute to the housing bubble. Rather, they found that on average the share of the purchase price covered by a mortgage was basically unchanged over the course of the boom, rising from about 84 percent in 1998 (before the boom began) to 88 percent at the peak of the bubble in 2006 and then dropping to about 80 percent by 2008 after the bubble had burst. Moreover, the changes were even smaller among the share of people who borrowed as much as possible. Nationally, in 1998 one-quarter of home purchasers borrowed about 96 percent of the total purchase price; by 2006 this figure had risen to 99 percent.
While the data do not explain the housing bubble, the authors do contend that the “the relatively modest link between interest rates and housing prices makes us more confident about rethinking [other] Federal housing policies,” most notably the ability to deduct mortgage interest from federal income taxes, a politically popular policy that many analysts believe is inefficient, unfair, and environmentally unsound. They also suggest that states such as Massachusetts that have restrictive local land use laws could reduce the extremity of its housing price cycles via policies that supersede local zoning or reward communities that allow for more housing.