How Debt-Ridden Housing Holds Back U.S. Recovery: Mian and Sufi

There is an emerging consensus that housing is weighing down the U.S. economy. The Federal Reserve’s housing white paper in January declared that “ongoing problems in the U.S. market continue to impede the economic recovery.” The 2012 Economic Report of the President argued that “declines in housing wealth can have a far greater effect on the economy than equivalent losses in other financial assets.”
Are these arguments sensible? Why should declines in house prices affect the broader economy? And why should the drop in housing wealth matter more than, say, a drop in stock-market wealth?
The key to understanding these questions is a four-letter word: debt.
In the absence of debt, economic theory tells us that house-price declines should have a negligible impact on aggregate output. To understand this argument, imagine a young recently married couple who own a one-bedroom condominium. They plan to start a family soon, and are looking to buy a bigger, more expensive house in the same neighborhood in the next few years.

Given their plan to upsize, a decline in house prices in the neighborhood makes them unambiguously “richer.” In the parlance of finance, the young couple are “short” housing services, and are better off when the price of such services declines.

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