1. 1 The Impact of Low Income Home Owners on the Volatility of Housing Markets Peter Westerheide ZEW European Real Estate Society Conference 2009 Stockholm June 26, 2009

2. 2 Outline Motivation Literature Review Data Methodology Empirical Results Conclusions and Outlook

3. 3 Motivation Default of low income home owners (subprime borrowers) has triggered the current crisis Usual focus is on the behavior of lenders, not of borrowers Lending without properly checking creditworthiness „Originate and distribute“ Our Focus: What is the role of low income housing demand? Can we observe any destabilizing impact of low income home ownership in the long run?

4. 4 Motivation Arguments in favor of destabilizing impact: Low income households face a higher income risk of unemployment have low liquid wealth and often no buffer stock to compensate income fluctuations are usually highly leveraged and have high interest/debt burdens cannot rely on bailout by relatives

5. 5 Motivation Competing arguments: Low income households are less mobile (relative income position and regional location) -> „trading up the ladder“ is less likely Wages are less variable than other components of income therefore total income might be less variable (as long as employed) Net effect depends on institutional framework, might be different in the housing cycle  Political target high home ownership rate: Is there a potential tradeoff to the stability of housing markets?

6. Level and volatility of income are correlated (Diaz-Serrano 2004, Dynan/Elmendorff/Sichel 2005, Jensen/Shore 2008) Extent of low income homeownership depends on completeness of mortgage markets (Chiuri/Japelli 2003, Bicacova/Siermienska 2007) Income volatility and probability of mortgage default 6 Literature Review IncomeMortgage market Housing prices Housing demand Financial leverage and volatility Volatility of income in different income classes Access to mortgage markets Structure of demand and volatility of markets Sensitivity of prices to income shocks depends on leverage (Lamont/Stein 1999, Benito 2006) Income volatility is related to mortage default (Diaz-Serrano 2004) Low income homeowners increase price volatility (Ortalo-Magné/Rady 2002) Down payment constraints affect the stability of housing markets (Ortalo-Magné/Rady 2005) Volatility of house prices depends on tax wedges (van den Noord 2005)

7. 7 Our approach Direct analysis of impact of low income home ownership on house price volatility in a cross country comparison 13 OECD countries, 1970-2006 Panel Regression with Fixed Effects Pooled VAR

8. 8 Data Most important problem: Data on distribution of home ownership and income No micro data for long time horizons Assumption of fixed distribution not realistic But: home ownership rate might be used as a proxy for share of low income households Empirical evidence supports this assumption

9. 9 Data Rate of Home Ownership Income HHO Country LHO Country Stylized fact: home ownership rate and income distribution

10. 10 Data Ratio of home ownership 2nd/9th income decile and average home ownership rate GE IT US FIN UK Own calculations, based on Bicacova /Siermienska (2007). Household head/spouse18-40 years old.

11. 11 Data Ratio of home ownership 3rd/9th income decile and average home ownership rate Own calculations, based on Bicacova /Siermienska (2007). Household head/spouse18-40 years old.

12. 12 Data  Proxy Homeownership Rate No annual data (except UK and US) Survey based, 4 – 10 years Common definition: Share of owner occupied dwellings in all dwellings Estimation of long term trends necessary  Assumption: high inertia  Short term fluctuations mainly reflect measurement error

13. 13 Data House Prices OECD Database, Girouard et al. 2006 Heterogeneous data, focussing mostly on used family homes Other data OECD and UN, gaps filled by interpolation based on national data: GDP per capita, long term interest rate, CPI, unemployment rate, debt/GDP-ratio

14. 14 Descriptive Evidence

15. 15 Descriptive Evidence

16. 16 Methodology Multivariate Regression: Volatility of house prices Volatility of Real Income Growth (proxied by Real GDP per Capita) Unemployment rate Interest Rate Debt-to-GDP ratio House Price growth Volatility of Inflation Rate (CPI) Home ownership rate Income Credit Market Prices

17. 17 Methodology Time Period 1970 – 2006 Problem: Measure volatility in sub periods that are long enough to show substantial variation… …but short enough to have sufficient data points in the time series dimension Tests with several period lengths Finally: 11 overlapping periods of 7 years

18. 18 Econometric Results Results of Regression for Nominal House Price Volatility Dependent Variable:  Volatility of Nominal House Prices Coeff.Std. Errort-valueP>|t| 95 % confidence interval  Volatility of CPI -0,0260,214-0,120,904-0,4500,398  Volatility of GDP 1,4600,3644,010,0000,7372,184  Interest Rate 0,7090,3092,290,0240,0951,322  Unemployment Rate -0,3270,244-1,340,183-0, 810,156  Debt to GDP Ratio 0,0410,0341,200,2340,0260,108  Growth Rate of Nominal House Prices0,2610,0813,200,0020,0990,422  Ownership ratio 0,7800,3442,270,0250,0981,463 Const.-0,0050,005-1,020,311-0,0160,005 R 2 = 0,366 117 Observations (9 periods/13 countries) Fixed effects regression, adjusted for serial correlation.

19. 19 Econometric Results Results of Regression for Real House Price Volatility Fixed effects regression, adjusted for serial correlation. Dependent Variable;  Volatility of Real House Prices Coeff.Std. Errort-valueP>|t| 95 % confidence interval  Volatility of CPI -0,0790,181-0,440,663-0,4390,280  Volatility of GDP 1,8960,3215,910,0001,2592,532  Real Interest Rate 0,1220,1930,630,530-0,2610,505  Unemployment Rate -0,1940,216-0,90,372-0,6230,235  Debt to GDP Ratio 0,0520,0271,930,0570,0020,105  Growth Rate of Real House Prices0,1740,0672,620,0100,0420,306  Ownership ratio 0,5040,2781,820,0720,0461,057 Const.-0,0130,004-3,280,001-0,020-0,005 R 2 = 0,332 117 Observations (9 periods/13 countries)

20. 20 Methodology Specification of a VAR with annual values 1970-2006 Are house prices more sensitive to shocks in HHO vs. LHO countries? Variables: real house prices, real interest rates, real GPD per capita, ownership ratio 2 lags

21. 21 Econometric Results Reaction to House Prices Reaction to GDP Reaction to Interest Rates

22. 22 Conclusion Ownership rate is proxy for share of low income home owners Some evidence for a positive correlation of home ownership rate and volatility of house prices Confirms theoretical findings

23. 23 Outlook Inclusion of better credit market indicator (mortgage market index) Account for age structures/demographic structures Test with US micro data for different regions? Refine estimation of VAR …

24. 24 Thank you for your attention!!! Contact: Peter Westerheide ++49 621 1235 146 westerheide@zew.de