Tuesday, November 13, 2007

Menzie Chen on the Credit Crunch


A couple of points. First, the fact that the yield curve is upward sloping again is probably good for the mortgage market (at least the prime market), because short borrowers can earns returns on the term structure. When I did my recent paper with Wachter, it was striking to me how bad an inverted yield curve seems to be for the mortgage market.

Second, while lots of home equity has been destroyed, I am not sure how important this is to the macroeconomy. I never bought the idea that home equity loans had a long term effect on aggregate demand, because they did not generally improve the household balance sheet (in exchange for cash, the household took on a new liability). Moreover, people tend not to sell their houses and cash out home equity until they are old. Consequently, the "wealth" effect arising from high house prices should largely have an impact on the elderly. For those who continue to consume the same quantity of housing, house prices are not so important.

The problem as I see it is largely from spillovers. To the extent credit spreads in general widen because of an absence on confidence, the economy will be slowed.

1 comment:

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