Systemic Risk And The Refinancing Ratchet Effect

The confluence of three trends in the U.S. residential housing market - rising home prices, declining interest rates, and near-frictionless refinancing opportunities - led to vastly increased systemic risk in the financial system. Individually, each of these trends is benign, but when they occur simultaneously, as they did over the past decade, they impose an unintentional synchronization of homeowner leverage. This synchronization, coupled with the indivisibility of residential real estate that prevents homeowners from deleveraging when property values decline and homeowner equity deteriorates, conspire to create a "Ratchet" effect in which homeowner leverage is maintained during good times without the ability to decrease leverage during bad times.

Provided by: Harvard Business School Topic: Data Management Date Added: Jun 2010 Format: PDF

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