The U.S. housing bubble burst more than 10 years ago, but the exact reasons for its inflation are still under debate. Consider the timing of the bubble (roughly 2002 to 2006) with the opening of the U.S. economy in 2000 to increased trade with China. A string of recent research finds that increased competition from Chinese imports leads to a significant deterioration in local labor markets. Perhaps there was some connection between these two trends as some U.S. households loaded up on debt in response to a weaker labor market. A recent working paper makes exactly that argument.
The paper is by economists Jean-Noël Barrot and Erik Loualiche of the Massachusetts Institute of Technology, Matthew Plosser of the Federal Reserve Bank of New York, and Julien Sauvagnat of Bocconi University. The four economists look to see if there was a difference in the amount of debt that households took on depending on how much import competition increased in their local economies. For those concerned that they might be finding a relationship that isn’t causal, the authors use an instrument for increased importation—a decline in shipping costs—that shouldn’t be connected to other factors increasing household debt.
Barrot, Loualiche, Plosser, and Sauvagnat find that increased import competition does explain a good amount of the variation in household debt. Areas with higher import competition saw higher increases in household leverage. An increase in competition of about one standard deviation explains about 30 percent of the difference in the growth of household debt. To get a sense of this magnitude, the authors find that a standard deviation increase in house prices also explains about 30 percent of differences in household debt.
Looking into the kind of debt that households take on in response to this shock, the four economists find that mortgage debt is the biggest part of the increase. Specifically, refinancing existing mortgages and home equity lines of credit are the biggest part of the increase, not new mortgages. This result fits in with the hypothesis that homeowners were taking out loans to deal with the loss of a job or a weakening labor market.
Previous studies of the cause of the housing boom emphasized the increases in credit supply, including the role of mortgage securitization and foreign savings flowing in the United States. What this new paper does is look at the source of increased credit demand in some areas of the United States. For many Americans, it appears that more debt and leverage wasn’t due to a desire to simply spend more, but instead a way to deal with a significant income drop. Access to credit served as a way to paper over some of the underlying problems in local labor markets.
Of course, the household bubble eventually burst and revealed the extent of those problems—an implosion that many Americans are still struggling to overcome.