Gabriel Chodorow-Reich, Professor, Harvard University
Abstract: With “2020 hindsight,” the 2000s housing cycle is not a boom-bust but rather a boombust-rebound at both the national level and across cities. We argue this pattern reflects a larger role for fundamentally-rooted explanations than previously thought. We construct a city-level long-run fundamental using a spatial equilibrium regression framework in which house prices are determined by local income, amenities, and supply. The fundamental predicts not only 1997-2019 price and rent growth but also the amplitude of the boom-bust-rebound and foreclosures. This evidence motivates our neo-Kindlebergerian model, in which an improvement in fundamentals triggers a boom-bust-rebound. Agents learn about the fundamentals by observing “dividends” but become over-optimistic due to diagnostic expectations. A bust ensues when overoptimistic beliefs start to correct, exacerbated by a price-foreclosure spiral that drives prices below their long-run level. The rebound follows as prices converge to a path commensurate with higher fundamental growth. The estimated model explains the boom-bust-rebound with a single fundamental shock and accounts quantitatively for cross-city patterns in the dynamics of prices, rents, and foreclosures.