The role of debt in real estate cycles

Published on September 30, 2020   15 min
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Hello. I'm Jaime Luque, I'm an Associate Professor at ESCP Europe. Before this I was a faculty at the University of Wisconsin, the School of Business in the Real Estate Department.
Today, we're going to talk about the role of debt in real estate business cycles. This is a very important topic. We're going to discuss how debt amplifies real estate boom and bust business cycles. We are going to illustrate all our discussions based on the recent subprime mortgage crisis. Now, all the materials shown in this lecture are based on the seminal paper by Professor Stephen Malpezzi, Residential Real Estate in the US Financial Crisis, the Great Recession and their Aftermath.
We all know what happened with the great financial crisis, but here are some key facts to understand the magnitude of these crises. Around July 2006, booming US house prices turned down, on average prices fell 30 percent in real terms before rebounding in 2012. Mortgage markets were also affected, as well as derivative securities markets. The largest originator countrywide was downgraded to near-junk bond status, and there were not only problems in the United States, they spilled overseas. For example, the UK Northern Rock bank went bankrupt. September 2008, Lehman Brothers collapsed and it provoked a massive global financial shock.
We want to make sense of the great financial crisis. There are so many potential causes, such as financial causes, political reasons, sociological reasons, psychological reasons. All of them had probably something to do with the great financial crisis. Here, we are going to have focus on two broad causes, financial leverage and the boom bust of housing prices.