The Great Recession: Lessons from Microeconomic Data

1. The Great Recession: Lessons from Microeconomic Data By: AtifMian and Amir Sufi

2. Introduction • Economic Crises, while undesirable, provide unique opportunities to test and further understand economic theory. • From the Great Depression we get: • John Maynard Keynes fiscal theory • Milton Friedman Monetarist tradition • Irving Fisher Debt Deflation • Goal: Incorporate Micro data and advancements in computational data to understand origin of the recession

3. What Were the Origins of the Credit Cycle: Credit Demand or Supply? • Financial crises are almost always preceded by a sharp rise in leverage or debt-based financing and there are two competing explanations for this: • Demand side or Supply side driven. • Demand side would be associated with positive productivity and/or technology shocks, increasing demand for credit. • Supply side would be associated with, in this case, financial innovation(securitization). • Kindleberger: “in many cases the expansion of credit resulted from the development of substitutes for what previously had been the traditional monies.”

4. Supply or Demand Driven? • Zip code level data on household borrowing points to supply driven. • Zip Codes that saw the largest increase in home purchases from ’02-’05 experienced declines in income. • Correlation between mortgage growth and income growth is negative from 02-05, while positive in all other periods since 1990. • In these zip codes mortgage denial rates dropped dramatically and debt to income ratios skyrocketed.

5. Does the Supply of Credit Influence Asset Prices? • Traditionally you price an asset by discounting future cash flows. The availability of credit plays no role in determination of asset prices. – A view which is now considered to be too narrow. • Geanakoplos “variations in leverage cause fluctuations in asset prices.” aka financial innovation or shifts in supply of credit directly impact asset prices, creating an important feedback mechanism. • Data suggests a credit-induced housing price Boom. • Bernanke: “the availability of these alternative mortgage products proved to be quite important and, as many have recognized, is likely a key explanation of the housing bubble.”

6. Do House Prices Have an Accelerator Effect? • The growth in the mortgage credit and house prices impacted economy through more than just the construction sector. • The major accelerator effect was driven by the impact of rising home equity on household spending. • Existing homeowners borrowed 25-30 cents against the rising value of their homes.

7. Do House Prices Have an Accelerator Effect? • This home equity based borrowing was not used to pay down debt or purchase new properties, but consumption and home improvement. • The home equity based borrowing channel was much stronger among households with low credit scores and high credit card utilization rates. • The most credit constrained homeowners were most aggressive in their home equity extraction response to housing price growth. • Accounts for $1.5 trillion increase in household debt.

8. The Household Leverage-Driven Recession • An expansion in the supply of credit, coupled with the feedback effect of borrowing against rising house values by existing homeowners, created an unprecedented growth in US household leverage between 02-06.

9. In Search of Fundamental Causes • Central argument is that an outward shift in the supply of credit from 02-06 was the primary driver of the macroeconomic cycle of 02-09. • What caused the shift? • Financial innovation • Subsidies for mortgage credit in the form of govt. homeownership initiatives and implicit govt. guarantees and expected bailouts.

10. Conclusion • “The widespread availability of microeconomic data has greatly enhanced our ability to understand the fundamental driving forces behind macroeconomic fluctuations and credit cycles. Our research has employed microeconomic data in order to understand the link between household finance and the real economy.”