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House Prices & Household Debt Laura Berlinghieri UW – Eau Claire

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Summary There is a positive and significant relationship between the median debt payment-to-income ratio and house prices. – This relationship differs across income groups. The debt payment-to-income ratio of households in the lower tail of the income distribution is more sensitive to house price fluctuations.

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Aggregate Debt-to-Income Ratio Sources: Federal Reserve; Bureau of Economic Analysis

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Household Debt and House Prices What are the possible relationships between these variables? 1. As additional households gain access to credit, the median debt-to-income ratio will likely increase.

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Homeownership Rate Source: U.S. Census Bureau

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Household Debt and House Prices What are the possible relationships between these variables? 2. As house prices rise, credit-constrained homeowners gain more access to credit. These homeowners are more likely to be in the lower income groups.

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Ratio of Debt Secured by Primary Residence to Household Income Source: Survey of Consumer Finances

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Survey of Consumer Finances Triennial survey – 1989 through 2007 waves Multiple imputation Dual-frame sample – Oversamples the wealthy Subject to large outliers – Use median regression

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Ratio of Monthly Debt Payments to Monthly Income Descriptive Statistics Survey Year1989199219951998200120042007 Max6.97399.1171.671093.8246.8043.65159.13 Min0.00 Median0.12 0.13 0.110.120.13 Mean0.180.450.300.600.210.220.37 Std. Dev.0.318.381.9419.661.121.024.24

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Median Monthly Payments Relative to Monthly Income, All Households Source: Survey of Consumer Finances

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Empirical Results, Part I Median regression first applied to: PIR i = β 1 + β 2 HousePrice i + δ 1 Y92 i + … + δ 6 Y07 i + γ 1 Q40 i + … + γ 5 Q100 i + β 3 Age i + β 4 Age i 2 + β 5 Age i 3 + β 6 HS i + β 7 College i + β 8 Homeowner i + β 9 Log(Income i ) + ε i Coefficient estimate for β 2 : 0.001 – Significant at 5% level

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Empirical Results, Part II Next, the median regression is applied to: PIR i = β 1 + β 2 HousePrice i + δ 1 Y92 i + … + δ 6 Y07 i + γ 1 Q40 i + … + γ 5 Q100 i + ζ 1 HousePrice i Q40 i + … + ζ 5 HousePrice i Q100 i + β 3 Age i + β 4 Age i 2 + β 5 Age i 3 + β 6 HS i + β 7 College i + β 8 Homeowner i + β 9 Log(Income i ) + ε i

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Relationship Between Payment-to-Income Ratio & House Prices… by Income Group Income Quantile Relevant Coefficient(s)Coefficient Estimate < 20% β 2 HousePrice i 0.815 20-39.9% β 2 HousePrice i + ζ 1 HousePrice i Q40 i 0.246 40-59.9% β 2 HousePrice i + ζ 2 HousePrice i Q60 i 0.121 60-79.9% β 2 HousePrice i + ζ 3 HousePrice i Q80 i 0.059 80-89.9% β 2 HousePrice i + ζ 4 HousePrice i Q90 i 0.035 90-100% β 2 HousePrice i + ζ 5 HousePrice i Q100 i 0.001

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Summary of Empirical Results There is a positive and significant relationship between the median debt payment-to-income ratio and house prices. – This relationship differs across income groups. The debt payment-to-income ratio of households in the lower tail of the income distribution is more sensitive to house price fluctuations. Results are robust to the choice of dependent variable.

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Results Default Rates The literature on default rates suggests a positive relationship between a borrowers debt payment-to-income ratio and the probability of default. – As house prices increase, credit-constrained households will likely respond by borrowing more. Monthly debt payments relative to monthly income will rise. – Probability of default increases as a result.

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