Low Mortgage Rates and Securitization: A Distinct Perspective on the US Housing Boom*

• Author: Helmut Herwartz,Fang Xu
• Date: 01 January 2020
• DOI: http://doi.org/10.1111/sjoe.12320
• Published date: 01 January 2020

Scand. J. of Economics 122(1), 164–190, 2020

DOI: 10.1111/sjoe.12320

Low Mortgage Rates and Securitization:

A Distinct Perspective on the US

Housing Boom*

Helmut Herwartz

Georg-August-University at G¨ottingen, DE-37073 G¨ottingen, Germany

hherwartz@uni-goettingen.de

Fang Xu

Brunel University of London, Uxbridge UB8 3PH, UK

fang.xu@brunel.ac.uk

Abstract

In this paper, we analyse the impacts of low interest rates and lax underwriting standards on

the US housing boom around the beginning of the new millennium. We suggest a time-varying

mean of the log price-to-rent ratio (PtR) to capture the persistent changes in housing prices.

We show that the increasing latent trend in the PtR was significantly affected by the increased

securitization of residential mortgage loans and decreasing interest rates, with the former effect

being about three times larger than the latter. In the absence of securitization, negative interest

rates would have been needed to reproduce an equallylarge housing boom since 2003.

Keywords: Dynamic Gordon growth model; house price-to-rent ratio; particle filter; state-space

model

JEL classification:C22; E44

I. Introduction

The US housing market’s boom and bust around the turn of the twenty-

first century has led to a chain reaction resulting in a global crisis.

The role of credit supply in this housing boom has received ample

attention. Among other factors, it has been pointed out that low interest

rates (e.g. Himmelberg et al., 2005; Leamer, 2007; Taylor, 2007), lax

underwriting standards due to securitization practices (e.g. Mian and Sufi,

2009; Keys et al., 2010), bad originator practices (Griffin and Maturana,

*Financial support by the German Research Foundation(HE2188/8-1) and Fritz Thyssen Stiftung

(Az.10.08.1.088) are gratefully acknowledged. We thank Franklin Allen, GraceW. Bucchianeri,

Roman Liesenfeld, Todd Sinai, Ron Smith, Roald J. Versteeg, and participants at the ESEM

conference and seminars of the EUI Florence, University of Pennsylvania and DIW Berlin for

their comments.

C

2018The Authors. The Scandinavian Journal of Economics published by John Wiley& Sons Ltd on behalf of F ¨oreningen

f¨or utgivande avthe SJE /The editors of The Scandinavian Journal of Economics.

This is an open access article under the terms of the Creative Commons Attribution License, which permits use, distribution

and reproduction in any medium, providedthe original work is properly cited.

H. Herwartz and F. Xu 165

2016), deregulation (Favara and Imbs, 2015), and risk-taking in lending by

banks encouraged by low short-term interest rates (Maddaloni and Jose-

Luis, 2011) have contributed to increased credit supply.

One of the most intense debates in this literature is the effect of the

interest rates versus the effect of the underwriting standards (securitization).

On one side, it is asserted that the low Federal Funds rate (Leamer, 2007;

Taylor, 2007) and the (related) decline in mortgage rates (Himmelberg etal.,

2005) have contributed to the housing boom. Lower real interest rates imply

lower financial costs of the mortgage loan, and potentially lower discount

rates for future cash flows from owning houses (Poterba, 1984). These, in

turn, lead to an increasing demand for housing and an acceleration of prices.

On the other side, Bernanke (2010) argues that only a small proportion of

the increase in house prices can be attributed to the stance of the monetary

policy – supporting evidence can be found, for example, in Del Negro and

Otrok (2007) and Glaeser et al. (2013) – and the deterioration in mortgage

underwriting standards is likely a key explanation of the run-up of house

prices. Using loan-level data, Keys et al. (2010) show that securitization

practices led to significant relaxations of underwriting standards. Analysing

data at the ZIP code level, Mian and Sufi (2009) confirm that the expansion

in subprime mortgage credit from 2002 to 2005 was closely correlated with

the increasing securitization of subprime mortgages. Through securitization,

additional funding sources for mortgage loans have endogenized the credit

supply (Shin, 2009).

In this paper, we contribute to the above-mentioned debate by looking

at the effects of both interest rates and securitization simultaneously. We

provide rare aggregate evidence on the relative impact of both factors on

trends in house prices. The framework of the analysis follows the asset

market approach using a dynamic variant of the Gordon growth model (e.g.

Campbell et al., 2009; Plazzi et al., 2010) for the log house price-to-rent

ratio (PtR). We adopt a generalized version of this approach, which allows

the local mean of the PtR to be time-varying. This is consistent with the

observed nonlinearity in house price dynamics. State and time dependence

of house price dynamics have inspired time series studies applying structural

breaks (e.g. Chien, 2010), regime-switching models (e.g. Hall et al., 1997),

and varying parameters (e.g. Guirguis et al., 2005). Allowing a time-varying

mean can be thought to generalize this line of modelling trends in house

prices. Changes in the mean of the PtR could be due to persistent changes

in expected return (risk) and economic fundamentals, such as productivity

and income gains. For the increases in the US house prices within

our considered period, however, the potential major contributors include

irrational house price patterns, expansionary mortgage credit policies, and

lax lending standards associated with securitization (Mian and Sufi, 2009).

C

2018The Authors. The Scandinavian Journal of Economics published by John Wiley& Sons Ltd on behalf of F ¨oreningen

f¨or utgivande avthe SJE /The editors of The Scandinavian Journal of Economics.