Conventional wisdom has typically blamed the rise of subprime mortgages for the Great Recession — and the housing boom that preceded it.
But a new working paper has examined the significant role housing speculation likely played, not only in the housing market’s pre-Recession boom and subsequent bust but also in the economy’s overall trajectory. Researchers found that speculative real-estate purchases on the part of investors were correlated with fluctuations in home prices as well as employment and household income at the local level.
A 10% jump in the share of non-owner-occupied home purchases in a given ZIP code between 2004 and 2006 was correlated with a 26.5% increase in home prices during the boom years. In the downturn, however, home prices fell 37.4% in these same areas. Interest rates during the boom years, which at the time were historically low, helped to drive interest in real-estate speculation, because the cost of financing was so affordable.
Housing speculation likely contributed to a higher level of construction activity in the areas where it was most prevalent. The uptick in housing supply this led to likely created “overhang” in those areas.
“Supply overhang can both exacerbate the subsequent housing price bust and reduce demand for new housing, leading to a large decline in construction activity during the recession,” the researchers wrote in the working paper, which was distributed by the National Bureau of Economic Research. “The impact could be even more pronounced than that in the boom since construction is irreversible.”
When the housing market soured, a higher prevalence of housing speculation in an area was correlated with a 14.6% drop in employment and 7.8% decrease in income per capita.
The fortunes of the housing market further bled over into the broader economy in the form of higher employment and income. That same increase in non-owner-occupied home purchases, which the researchers used as an indicator of housing speculation, was correlated with upticks in employment (8.4%) and per capita income (12.9%).
When the housing market soured though, a higher prevalence of housing speculation in an area was correlated with a 14.6% drop in employment and 7.8% decrease in income per capita. The drop in employment didn’t just stem from a decrease in construction jobs. The researchers noted that a 10% increase in speculative housing sales in the boom era was linked to a 15.6% drop in employment in the retail and restaurant sectors during the subsequent bust.
Consequently, as with home prices, the degree to which housing speculation made the downturn worse was larger than the boost it initially gave the economy in the boom years. The researchers also performed their analysis while excluding data from states where the housing boom was especially pronounced, such as California, Nevada and Florida, finding that speculation still played a major role in the recession experienced in other parts of the country.