in home improvements and maintenance, which leads to the overall decline in the quality of the nation’s housing stock (Melzer 2010).
Negative equity has also been associated with heightened realized default rates. Several recent academic and industry studies have found that the higher their negative equity, the more likely households are to become delinquent (Bajari, Chu, and Park 2010; Elul et al. 2010). Recent work by Federal Reserve Board economists (Bhutta, Dokko, and Shan 2010) shows that a household’s equity position amplifies the effect of unemployment shocks on default and that this interaction grows in strength with the degree of negative equity. (For more on data challenges in evaluating the financial situation of homeowners, see Data Watch 4-1). Household delinquency and the ensuing foreclosures are very costly, as they disrupt the social fabric of neighborhoods and cause lenders to engage in an expensive and drawn-out process of liquidation. Moreover, foreclosures not only lower the value ofthe foreclosed property itself; they also have a sizable spillover effect on valuations of neighboring homes. According f to a recent academic study (Campbell, Giglio, and Pathak 2011), each foreclosure within a 0.1 mile radius of a given house lowers its predicted sale price by 7.2 percent.
Negative equity also poses a roadblock for efficient reallocation of housing resources. Families naturally buy and sell houses over their life cycle and in response to shocks such as illness or divorce. The necessity to write a sizable check to the lender upon sale makes it effectively impossible for liquidity-constrained households to trade their houses without creditimpairing actions such as delinquency; deed-in-lieu, in which a borrower returns the property to the lender; or short sale, in which a house is sold for less than the balance of debts secured by the property. Negative equity also has the potential to limit underwater borrowers’ ability to pursue employment opportunities in other geographic areas. The empirical evidence to date, however, has largely suggested that the adverse effect of negative equity on labor mobility—the so-called “house lock effect”—is fairly limited.
Macroeconomic Effects of
Housing Market Weakness
The housing sector plays an important role in determining the health of the broader economy. Two aspects of this relationship are particularly important—the effect of housing wealth on household consumption and the direct contribution of residential construction to gross domestic product (GDP).
