Explains how we got into the current economic disaster that developed out of the economics and politics of the housing boom and bust. The "creative" financing of home mortgages and "creative" marketing of financial securities based on these mortgages to countries around the world, are part of the story of how a financial house of cards was built up--and then collapsed.

"I test the credit-market effects of housing wealth shocks by estimating the consumption elasticity of house price shocks among households in different age quintiles. Younger households face faster expected income growth and hence would like to borrow more than older households. I estimate consumption elasticities from housing wealth by age quintile to be (4; 0; 3; 8; 3) percent. As predicted by theory, the youngest group has a higher elasticity of consumption than the next two age quintiles. That the consumption of the age quintile on the verge of retirement is responsive to housing wealth is also not surprising: I show that these households are likeliest to "downsize" their house and thus realize any capital gains"--Abstract.

We study a two-sector general equilibrium model of housing and non-housing production where heterogenous households face limited opportunities to insure against aggregate and idiosyncratic risks. The model generates large variability in the national house price-rent ratio, both because it fluctuates endogenously with the state of the economy and because it rises in response to a relaxation of credit constraints and decline in housing transaction costs (financial market liberalization). These factors, together with a rise in foreign ownership of U.S. debt calibrated to match the actual increase over the period 2000-2006, generate an increase in the model price-rent ratio comparable to that observed in U.S. data over this period. The model also predicts a sharp decline in home prices starting in 2007, driven by the economic contraction and by a presumed reversal of the financial market liberalization. Fluctuations in the model's price-rent ratio are driven by changing risk premia, which fluctuate endogenously in response to cyclical shocks, the financial market liberalization, and its subsequent reversal. By contrast, we show that the inflow of foreign money into domestic bond markets plays a small role in driving home prices, despite its large depressing influence on interest rates. Finally, the model implies that procyclical increases in equilibrium price-rent ratios reflect rational expectations of lower future housing returns, not higher future rents.

Just as investors want the companies they hold equity in to do well, homeowners have a financial interest in the success of their communities. If neighborhood schools are good, if property taxes and crime rates are low, then the value of the homeowner’s principal asset—his home—will rise. Thus, as William Fischel shows, homeowners become watchful citizens of local government, not merely to improve their quality of life, but also to counteract the risk to their largest asset, a risk that cannot be diversified. Meanwhile, their vigilance promotes a municipal governance that provides services more efficiently than do the state or national government. Fischel has coined the portmanteau word “homevoter” to crystallize the connection between homeownership and political involvement. The link neatly explains several vexing puzzles, such as why displacement of local taxation by state funds reduces school quality and why local governments are more likely to be efficient providers of environmental amenities. The Homevoter Hypothesis thereby makes a strong case for decentralization of the fiscal and regulatory functions of government.