Crs Report for Congress

After years of rapid appreciation, house prices barely rose in the second quarter of 2007, and many analysts expect price declines in many markets in the near future. There have already been large drops in house sales and residential investment (house building). Given the central role that the housing boom has played in the current economic expansion, many observers fear that a crash in the housing market will lead to an economy-wide recession. They are concerned that a fall in house prices could spill over into a decline in aggregate spending through four channels. First, builders could respond to lower prices by reducing residential investment, an important component of gross domestic product (GDP). Second, since mortgages are backed by the value of the underlying house, a fall in prices could feed through to financial instability. Both of these effects have already been felt, with the rate of residential investment falling by double digits since mid-2006, and the entire financial sector undergoing a liquidity crunch triggered by problems with subprime mortgage-backed securities in August 2007. Third, a fall in housing prices could lead to a decline in consumer spending through a negative "wealth effect." Some economists have argued that when house ...