Efficient Credit Policies in a Housing Debt Crisis

Efficient Credit Policies in a Housing Debt Crisis

By
Janice Eberly, Arvind Krishnamurthy
Brookings Papers on Economic Activity.
2014, Issue Fall

Should another housing market crash occur, the government’s highest priority should be helping cash-short homeowners maintain spending in a weak economy and avoid foreclosure by temporarily reducing or deferring mortgage payments.

In this paper, Janice Eberly of Northwestern University and Arvind Krishnamurthy of Stanford University build a theoretical framework to guide policymakers ahead of a housing collapse and in the aftermath, finding that reducing the loan principal spreads the benefits of government funds over a long period of time, rather than focusing on the crisis period. The housing bust of the late 2000s was at the heart of the worst recession since the Great Depression, and resulted in a set of government programs to help beleaguered homeowners and cushion the blow to the overall economy. The authors focus on the importance of liquidity constraints and consumer spending in the overall economy, especially during a financial crisis when there is a need to support household consumption.