The mess

Richard’s Real Estate and Urban Economics Blog: Why an Interest Rate Freeze won’t solve the Subprime Problem

I am still confused about exactly what news caused the meltdown.  There are lots of good reasons to be worried about the feedback from house prices to the overall level of economic activity, and then back to house prices, etc, leading to predator-prey dynamics: Lotka-Volterra equation – Wikipedia, the free encyclopedia

The idea is in an important paper by Kiyotaki and Moore (not with personal real estate, but could be extended to that setting too I think).

Credit Cycles: Kiyotaki and Moore

The authors construct a model of a dynamic economy in which lenders cannot force borrowers to repay their debts unless the debts are secured. In such an economy, durable assets play a dual role: not only are they factors of production but they also serve as collateral for loans. The dynamic interaction between credit limits and asset prices turns out to be a powerful transmission mechanism by which the effects of shocks persist, amplify, and spill over to other sectors. The authors show that small, temporary shocks to technology or income distribution can generate large, persistent fluctuations in output and asset prices.

Transmission mechanism roughly means how shocks in one part of the economy are transferred to other sectors and propagate through time.

I wonder if the appropriate policy response is to somehow loosen up collateral constraints, rather than play around with people’s mortgages.

Addendum: here is why I don’t think resets matter as much as everyone thinks, but the house price itself does matter a lot
NPR: Why Not Just Walk Away from a Home?.

Key quote:

Sometimes, they say, walking away from your mortgage makes economic sense, especially for homeowners who find themselves “upside down” — that is, they owe more on their mortgage than their house is worth

Owing is the stream of payments, not simply the current payment.

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