Economics & Finance
• 4 minute read

Is Speculation in Housing Markets to Blame for Deeper Recessions?

Gao, Zhenyu(高振宇)

CUHK research looks at how speculative activity in real estate could lead to more aggravated swings in economic cycles

By Jaymee Ng, Principal Writer, China Business Knowledge@CUHK

The U.S. housing market crash of 2008 has been called, hands down, the most disruptive event of the century. Riding on then-historically low interest rates and a speculative fever, investors piled into real estate, only to get seriously burnt when prices came crashing to earth. Many Americans lost their life savings, jobs and businesses in the process, and it contributed to the start of a deep recession that lasted into the second quarter of 2009.

That dark episode in American economic history was the basis of a new study by The Chinese University of Hong Kong (CUHK), which looked at how speculative activity in housing markets has led to aggravated swings in the economic cycles of booms and busts.

“Housing speculation had real economic consequences during the boom, by increasing housing prices and fueling local economic expansions, and during the recession, by depressing residential construction employment, as a result of supply overhang, and by reducing local household demand,” says Prof. Zhenyu Gao, Associate Professor in Finance at CUHK Business School and one of the study’s authors.

“We find that areas with a greater share of home purchases that are not occupied by their owners during the boom … experienced greater swings in employment, payroll, per capita income, and the number of business establishments.” – Prof. Zhenyu Gao

The study, detailed in the paper Economic Consequences of Housing Speculation, was conducted in collaboration with Prof. Michael Sockin at University of Texas at Austin and Prof. Wei Xiong at Princeton University.

The researchers reviewed home mortgage data in the U.S. from 2000 to 2010. They divided the housing cycle into three phases: the pre-boom period (2001-2003), the boom period (2004-2006) and the bust period (2007-2009). Housing speculation was measured by the percentage of home purchases that ended up not being occupied by their owners against the all home mortgages taken out during the period. The idea is that purchasing a home other than as the primary residence signifies speculative motives to a certain extent.

Boom v. Bust

According to the study, non-owner-occupied home purchases comprised 15.31% of new mortgage originations nationwide in 2005. It found that an increase of 9.9% in the share of non-owner-occupied home purchases in 2004-2006 led to a housing price increase of 26.5%, an increase of 13.7% in payroll, 8.4% in employment, 12.9% in per capita income and 6.8% in the number of new businesses being established during the boom. In contrast, during the bust period between 2007 and 2009, a 9.9% increase in non-owner-occupied home purchases was linked to a drop of 37.4% in housing prices, 15.4% in payroll, 14.6% in employment, 7.8% in income per capita and 8.7% in the number of business establishments.

“As U.S. states have significant variation in how they tax capital gains, housing speculation is more intensive in states with either no or low capital gains taxes,” says Prof. Gao. “We find that areas with a greater share of home purchases that are not occupied by their owners during the boom had not only more pronounced housing cycles, but also experienced greater swings in employment, payroll, per capita income, and the number of business establishments.”

In particular, the construction industry suffered the most from housing speculation as it is directly related to the supply of housing markets. An increase of 9.9% in non-owner-occupied home purchases led to an increase of 25.1% in employment in the construction sector and of 6.1% in other sectors during the boom. Consequently, such an increase is also associated with a decrease of 33.8% in employment in the construction sector and 12.4% decrease in other sectors during the bust.

“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 impact could be even more pronounced than that in the boom since construction is irreversible,” Prof. Gao comments.

Impact on Different Sectors

To get a more holistic picture of how housing speculation affects non-construction sectors, the researchers analysed the impact on non-tradable sectors – industries whose output consist of goods and services that could not be traded internationally, such as healthcare and education, and are typically consumed within a given local region – as well as the retail and restaurant sectors which also rely on local consumption demand.

The results show that an increase of 9.9% in non-owner-occupied home purchases is associated with an increase of 8.8% increase in the employment of non-tradable sectors and 8.9% increase in the employment of retail and restaurant sectors during the boom. This is in contrast to a decrease of 15.1% and 15.6% during the bust period studied. The study also highlighted that housing speculation had a more modest effect on employment in tradable sectors and industries other than retail and restaurant sectors, as they are able to rely more on national demand.

“Taken together, our analysis provides evidence that housing speculation affected real economic outcomes during the Great Recession through the supply overhang and the local demand channels. Since employment in residential construction contributes to local demand, these two channels are likely complementary, and it is reassuring that we find that both are significant in contributing to the severity of the local recessions during the bust,” Prof. Gao says.

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