FORECLOSURES, HOUSE PRICES, AND THE REAL ECONOMY

A central idea in macroeconomic theory is that negative price effects from the leverage-induced forced
sale of durable goods can amplify negative shocks and reduce economic activity. We examine this
idea by estimating the effect of U.S. foreclosures in 2008 and 2009 on house prices, residential investment,
and durable consumption. We show that states that require judicial process for a foreclosure sale have
significantly lower rates of foreclosures relative to states that have no such requirement. Using state
laws requiring a judicial foreclosure as an instrument for actual foreclosures, as well as a regression
discontinuity design around state borders with differing foreclosure laws, we show that foreclosures
have a large negative impact on house prices. Foreclosures also lead to a significant decline in residential
investment and durable consumption. The magnitudes of the effects are large, suggesting that foreclosures
have been an important factor in weak house price, residential investment, and durable consumption
patterns during and after the Great Recession