This paper documents and explains previously unrecognized dynamics following the collapse of a housing bubble. A simple model predicts that supply adjustments by speculative developers ensure stable pre-crash relative prices between low- and high-quality segments of the market. Post-crash exit of developers removes that disciplining effect which allows relative prices to potentially diverge, in which case lower quality segments must fall further so that the rank order in prices across quality segments is preserved. Market recovery implies the return of developers causing relative prices to revert back to their pre-crash levels.
We implement the model using size-stratified repeat sales measures of house price inflation for Phoenix, Arizona. Although home prices doubled 2004-2006, relative prices of small-to-large homes remained stable. Post-crash, a remarkable monotonic pattern of relative prices appears, with smaller home values falling further than larger home values prompted in part by increased turnover associated with distressed sales in smaller home market segments. As markets have begun to recover since 2011, much of the divergence in relative prices has disappeared. Anticipated mean reversion indicates that cities can reduce post-crash volatility and possible mispricing by publicizing size-stratified repeat sale house price indexes.
Joint with Crocker H. Liu and Adam Nowak.