The note delves on the U.S. housing market outlook, the potential benefits of mitigating distressed sales household deleveraging, and the recovery. Policies to facilitate labor market adjustment to reduce the large employment volatility without affecting efficient labor allocation could prevent problems. U.S. firms are hoarding money but it is likely to be spent to boost firms’ capital expenditure, rather than kept as precautionary balances. The note discusses commodity price shocks affecting Treasury inflation protected securities (TIPS), budget institutions for federal fiscal consolidation, and mortgage delinquencies in the United States.


The note delves on the U.S. housing market outlook, the potential benefits of mitigating distressed sales household deleveraging, and the recovery. Policies to facilitate labor market adjustment to reduce the large employment volatility without affecting efficient labor allocation could prevent problems. U.S. firms are hoarding money but it is likely to be spent to boost firms’ capital expenditure, rather than kept as precautionary balances. The note discusses commodity price shocks affecting Treasury inflation protected securities (TIPS), budget institutions for federal fiscal consolidation, and mortgage delinquencies in the United States.

I. The U.S. Housing Market Outlook—What are the Potential Benefits of Mitigating Distressed Sales?1

The housing market still faces headwinds. Construction activity and sales hover around historic lows and prices have fallen again in recent months. With a large housing inventory already on the market and a large “shadow inventory” of distressed properties that could enter the market, we expect only a subdued recovery in house prices over the medium term. We update prior research by Fund staff and confirm that foreclosure starts have a large negative effect on house prices, suggesting that effective foreclosure mitigation policies could have measurable macroeconomic benefits.

A. introduction

1. The housing market remains weak (Box 1). Housing starts, building permits, and sales remain close to historic lows while house prices have fallen since the expiration of temporary homebuyers’ tax incentives in mid-2010, although at a declining clip. The outlook remains clouded, with a sizable “shadow inventory” of houses that are likely to come on the market through distressed sales.2 Most analysts and staff expect further price declines in the near term and a recovery in housing activity to levels consistent with demographic trends only after 4–5 years (MacroMarkets, 2011).


House Price Indices

Citation: IMF Staff Country Reports 2011, 202; 10.5089/9781462317356.002.A001


House Price Forecasts

Citation: IMF Staff Country Reports 2011, 202; 10.5089/9781462317356.002.A001

Sources: MacroMarkets LLC; Standard & Poors; Federal Housing Finance Agency; National Association of Realtors; Haver Analytics; and Fund staff estimates.

2. The anemic level of residential construction is largely the natural—and necessary—consequence of past overbuilding. Vacancy rates remain well above normal frictional levels, reflecting both the overbuilding during the housing boom as well as the subdued pace of household formation since the crisis. High vacancy rates, in turn, are weighing on new residential construction activity.3 We estimate excess vacancies to be currently around 3 million units, based on deviations of vacancy rates from historic averages. Residential construction is expected to increase to an annual rate of around 1.2 million units by 2015 (much higher than the current ½ million), close to past trends in household formation, as vacancy rates return to normal levels.

B. Weak Demand, Elevated Inventories, and Distress Sales Bearing on House Prices

3. The inventory of houses for sale remains unusually high, putting downward pressure on house prices. Despite a very subdued pace of residential construction, the inventory of existing houses for sale is equivalent to around 9¼ months of current sales—well above the historical average of 6 months.4 This elevated inventory-to-sales ratio reflects both the large stock of houses for sale and the very subdued sales pace (existing home sales are around 5 million in annualized terms, compared to a peak of over 7 million during the housing boom).

4. The supply of houses for sale could remain high for some time, given the large stock of mortgages that are either in the foreclosure process or severely delinquent, or likely to default in the future. We estimate the glut of properties that could enter the market through distress sales—often referred to as shadow inventory—at around 6 million:5 The shadow inventory includes:

  • The 2.3 million houses currently in the foreclosure process. In 2010, according to Realty Trac (2011), there were a record 2.9 million foreclosure filings (by contrast, around 550,000 foreclosures took place each year between 2000–05).6 Foreclosure activity has been subdued so far in 2011, with a 40-month low in April largely due to a temporary freeze in foreclosure processing amid documentation problems, with banks facing increasing scrutiny, lawsuits from states, and investigations from various federal agencies (Box 2).

  • An additional 1.8 million mortgages at risk of becoming foreclosed with payments past due for at least 90 days. Under historical norms for delinquency rates, about 400,000 mortgages would have been past due for 90 days or more given the current number of outstanding mortgages.

  • Around one million underwater mortgages that are still being serviced but could potentially become delinquent.7 Corelogic (2011) estimates that at the end of the first quarter of 2011 as many as 11 million mortgaged properties were underwater with another 2.4 million borrowers only five percent shy from negative equity. The aggregate level of negative equity was around $750 billion at end-2010.8 Strategic defaults—the decision by a borrower to default despite having the financial ability to make the payments—are closely associated with negative equity. Strategic defaults are estimated to have accounted for as much as 31 percent of all defaults in 2010, as compared to about 4 percent in mid-2007 (Guiso et al., 2011, Sapienza and Zingales, 2010).

  • Around one million in modified mortgages with a high re-default risk (given a re-default rate of around 40 percent within a year of modification for private servicer mortgages, OCC (2011)).


Aggregate Dollar Volume of Negative Equity by Segment

Citation: IMF Staff Country Reports 2011, 202; 10.5089/9781462317356.002.A001

Sources: FirstAmerican CoreLogic and Fund staff calculations.

5. Distress sales form a key impediment to a faster housing market recovery. Foreclosed properties not only add to the housing inventory for sale but they often sell at a significant discount of as much as 27 percent (Campbell et al., forthcoming); in addition, foreclosed properties dampen neighboring house prices by 1½–2 percent (Hartley, 2010). The shadow inventory of houses could enter the market through distressed sales and exert additional downward pressure on house prices if markets have not already incorporated this potential future source of supply in existing prices. Furthermore, the shadow inventory raises the uncertainty as to when house prices would reach the bottom, possibly keeping prospective home buyers and investors out of the real estate market. It is also possible that house prices are depressed just by the uncertainty about these channels.

C. What is the Outlook for Home Prices?

6. Staff estimates suggest that foreclosures are indeed associated with downward pressure on house prices at the aggregate level. We updated the Klyuev (2008) house price model using data up to 2011Q1. We find that the inventory-to-sales ratio (a measure of imbalance between supply and demand in the housing market) and foreclosure starts are important determinants of house price developments. A 20 percent increase in the inventory-to-sales ratio would weaken house prices by almost 0.15 percentage points in the next quarter. And foreclosures not only lower prices by adding to the inventory of for-sale properties, but also exert additional significant downward pressure on prices on their own (Table 1).9 We also attempt to control for the deviation of actual house prices from levels suggested by economic fundamentals (the “price gap”, calculated as residuals in an estimated equation linking the ratio of house prices to rents and the real interest rate); we find that the gap is a statistically significant determinant of quarterly price changes but its impact is economically small.

Table 1.

Model Analysis

article image
Source: Author’s calculations.Note: One, two, or three stars indicate significance at the 10, 5 and 1 percent level, respectively.

The price gap was estimated as the residual of an equation linking house price-to-rent ratio and real interest rates using dynamic OLS estimation for the period 1970Q1–2010Q4. The coefficient of the real interest rate (-0.0404) was statistically significant at the 1 percent level.

7. We project house prices under the assumption that sales gradually return to normal levels and the shadow inventory enters the market over the next 2–3 years. We project home prices using the estimated equation based on projected paths for the inventory-to-sales ratio, foreclosure starts, and the price gap (Figure 1). We assume that all economic fundamentals governing house price changes will return to their historical averages over the medium term. Foreclosure starts will remain at the current elevated levels until 2013 given the large shadow inventory and then gradually decline to the long-run average of around 600,000 annually.10 Similarly, the inventory to sales ratio would remain elevated for the next 2–3 years given the foreclosed properties entering the market but it would return to its historical average of 6 months supply of sales as the pace of sales normalizes (with the sales-to-population ratio gradually returning to its historic average). To calculate the price gap, we assume that real rents would continue to increase in the short run; once real rents revert to their long-run average, nominal rents would start to grow at the rate of headline inflation.

Figure 1.
Figure 1.

United States. Simulation and House Price Dynamics, 1995–2015

Citation: IMF Staff Country Reports 2011, 202; 10.5089/9781462317356.002.A001

Sources: Haver Analytics and Fund staff projections.1/ In the baseline scenario, 6.8 million foreclosures occur between 2011Q3 and 2013-Q4.2/ Preventing 1 million foreclosures vis a vis baseline scenario with houses not entering the real estate market.3/ Preventing 1 million foreclosures vis a vis baseline scenario with houses entering the real estate market.

8. Based on these simulations, we project a subdued and protracted recovery in house prices (Figure 1 and Table 2). Both staff and consensus expect further weakening in house prices in the near term, with staff projecting somewhat larger declines consistent with its below-consensus economic outlook. However, we see somewhat greater momentum over the medium term as foreclosures and the housing inventory decline to normal levels. We expect house prices to increase by only 4½ percent between end-2010 and end-2015 (Table 2).

Table 2.

Expected Nominal Home Price Changes by Year

(in percent)

article image
Sources: MacroMarkets and Fund staff projections.

In the baseline scenario, 6.8 million foreclosures occur between 2011Q2 and 2013-Q4.

Preventing 1 million foreclosures vis a vis baseline scenario with houses not entering the real estate market.

Preventing 1 million foreclosures vis a vis baseline scenario with houses entering the real estate market.

9. We also examined a scenario where one million foreclosure starts are averted between 2011Q3 and end-2013, through the enactment of foreclosure mitigation policies (e.g., as discussed in Chapter 9). In that case, since distressed sales would be avoided, house prices would be 3¼–4 percent higher by 2015 compared to the baseline scenario, depending on whether the properties (for which foreclosures are averted) eventually enter the market or not. In particular, if the one million properties are not posted for sale by 2015 (that is, if the households retain their properties), then house prices would be 4 percent higher than in the baseline scenario. If distress sales are avoided but the one million properties are nonetheless posted for sale, then house prices would be 3¼ percent higher than in the baseline scenario.

D. Conclusion

10. The U.S. housing market remains depressed, given a large overhang of vacant or distressed properties—a key legacy of the housing bubble. We expect moderate house price declines in 2011 and only modest increases over the medium term, broadly in line with consensus forecasts. House prices are projected to increase only by 4½ percent between end-2010 and end-2015, with foreclosures remaining significantly elevated through 2013.

11. Our analysis suggests that policies to mitigate distress sales would have a significant positive impact on house prices. We estimate that avoiding one million foreclosures through 2013 could raise house prices by 3¼-4 percent by end-2015 compared to the baseline scenario. These estimates could be on the low side since they ignore the potential improvement in homebuyer sentiment from reducing the uncertainty surrounding the housing market outlook by reining in the shadow inventory.

The U.S. Housing Market: Some Basic Facts1

There are a large number of players in the U.S. mortgage market, involved with originating, funding and servicing mortgages. Loans are made (originated) by a huge variety of retail finance institutions, including banks, mortgage brokers and finance companies. The most typical loans are: (i) conforming mortgages, which satisfy certain legally mandated restrictions on credit risk and size and are most often securitized by the Government Sponsored Enterprises (GSEs); (ii) jumbo mortgages, which are large mortgages with higher than normal credit risk (given the larger loan balances and the fact that the properties are more expensive and thus tend to be harder to sell) typically securitized by private entities; and (iii) government-backed mortgages, guaranteed by the Federal Housing Administration (FHA) and the Veterans’ Administration.

Before the crisis, mortgage lenders have fund their loans with a mix of equity, debt and secondary market transactions. There was a well-developed secondary mortgage market comprised of GSEs, which fund conforming loans, and private mortgage conduits, investment banks, and pools of managed assets. This market allowed lenders to transform the mortgage into a highly-rated liquid security.

Mortgage servicers play an important role. Servicers are responsible with the day-to-day business of managing payments from borrowers and are usually responsible for handling delinquent borrowers. In return, they charge a small fraction of the mortgage monthly payment as a fee. Servicers are typically required to advance scheduled principal and interest payments to the holder even if the borrower is delinquent; but they are later reimbursed of all out-of-pocket expenses incurred during the foreclosure proceeding (Cordell et al., 2008), making it less than clear if it is profitable for the servicer to offer mortgage modifications (Eggert, 2007).

Foreclosure laws vary widely by state, with 23 states requiring a judicial foreclosure process. In these cases, the court oversees and approves each stage of the foreclosure process, making it much lengthier (prior to a foreclosure, the borrower must be delinquent for at least 90 days). Typically in states where non-judicial foreclosures are authorized, most loans are considered non-recourse (i.e., the lender cannot go after the borrower’s other assets in case of default). The 18 non-recourse states include Florida and California.

1 The analysis draws heavily from Lehnert (2011).

The Mortgage Legal Documentation Problem1

In September 2010, many banks temporarily suspended foreclosures as a result of potential technical deficiencies in necessary legal documentation relating to the handling of mortgage “notes” that set the terms and conditions of the loans.2 In many cases, transfers of the notes were improperly executed or were misplaced. When the note is missing, a notarized lost note affidavit along with a copy of the note can be presented. However, in their haste to process large volumes of foreclosures, in some cases the affidavits were signed by “robo-signers”—individuals who did not have the necessary personal knowledge of the validity of the missing notes—or were not properly notarized. Following these allegations, some homeowners challenged the validity of foreclosure proceedings altogether.

Another part of the securitization chain that has been raising concerns is the role of the Mortgage Electronic Registration System (MERS) used by many lenders to record the ownership chain of a mortgage. MERS records have been challenged in the courts before with mixed results depending on the jurisdiction.

1 The box includes contributions by John Kiff.2 A “mortgage loan” consists of two parts, (i) the notes, which are negotiable instruments that transfer along the securitization chain from the originator to the sponsor and ultimately to the trust and (ii) the lien, that gives the holder the right to take away the underlying property if any of the terms and conditions of the note is violated


  • Amherst, 2011a, “Outlook and Opportunities in the U.S. RMBS Market,” Presentation Book April.

  • Amherst, 2011b, “Borrowers stay current on 2nd lien for liquidity,” available at:

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  • Campbell, J.Y., S. Giglio, and P. Pathak, forthcoming, “Forced Sales and House Prices,” American Economic Review.

  • Cordell, L., K. Dynan, A. Lehnert, N. Liang, and E. Mauskopf, 2008, “The Incentives of Mortgage Servicers: Myths and Realities,” Finance and Economics Discussion Series Divisions of Research & Statistics and Monetary Affairs 2008–46, Federal Reserve Board, Washington, D.C.

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  • Corelogic, 2011, Negative Equity Report.

  • Eggert, K., 2007, “Comment: What Prevents Loan Modifications?” Housing Policy Debate, Vol. 18, pp. 27997.

  • Foote, C. L., K. Gerardi, and P.S. Willen, 2008, “Negative Equity and Foreclosure: Theory and Evidence,” Journal of Urban Economics, Vol. 64(2), pp. 23445.

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  • Goldman Sachs, 2011, “Excess Vacant Units,” excerpt available at:

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  • Guiso, L., P. Sapienza and L. Zingales, 2011, “The Determinants of Attitudes Towards Strategic Default on Mortgages,” EUI Working Paper, European University Institute.

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  • Hartley, D., 2010, “The Effect of Foreclosures on Nearby Housing Prices: Supply or Disamenity?,” Working Paper 10–11, Federal Reserve Bank of Cleveland.

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  • Klyuev, V., 2008, “What Goes Up Must Come Down? House Price Dynamics in the United States,” IMF Working Paper 08/187, Washington, DC: International Monetary Fund.

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  • MacroMarkets, 2011, Home Price Expectations Survey, June.

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  • Realty Trac, 2011, U.S. Foreclosure Trends and Foreclosure Market Statistics, available at:

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Prepared by Evridiki Tsounta (WHD). The paper has benefited from numerous conversations with Oya Celasun and John Kiff. Special thanks to Vladimir Klyuev for providing the code for his housing model and to Grace Bin Li for updating it.


Distress sales typically include foreclosed properties and short sales. They represented over a third of all homes sold in the past 2 years (the most recent observation for the share of distress sales, for May 2011, was about 30 percent of sales). The Corelogic National Home Price Index including distress sales is down 33 percent from its peak and 21 percent excluding such sales.


Estimates of excess vacancies range between 1½ and 4½ million units, depending on the assumptions for equilibrium household formation and construction activity (Lawrel, 2011 and Goldman Sachs, 2011). According to Marple (2011), household formation, which is a key driver of the construction of new housing, has fallen to 0.3 million in 2010 versus 1.6 million in 2007, given dismal labor market conditions (particularly for those below age 35).


Only a small fraction of foreclosed properties is included in this inventory stock.


There is a large variation in shadow inventory estimates, which mostly reflect differences in the definition used; for example, some analysts only include seriously delinquent mortgages in the definition.


A foreclosed property might have more than one filing if there are junior mortgage liens. It is estimated that around 10 percent of the mortgaged value is in unsecured-second liens (Amherst, 2011a). According to Amherst (2011b), the percentage of second loans bundled into securitizations is negligible.


We assume that 10 percent of the 11 million underwater mortgages would default, consistent with the experience of Massachusetts in the 1990s as analyzed in Foote et al. (2008).


There are around 52 million households with a mortgage out of 130.8 million housing units; household mortgage debt outstanding was $10 trillion at end-2011Q1 with housing value estimated at $16.1 trillion.


Foreclosures influence prices with a lag since it takes time for the foreclosure process to run its course and add to inventory and for information to affect market sentiment and lending standards (Klyuev, 2008).


Specifically, staff projects that foreclosures would stay at their current elevated level for the next two years with almost 7 million foreclosures taking place between 2011Q2 and 2013Q4 given (i) the large shadow inventory of houses for sale and (ii) the negative outlook for house prices that could result in additional underwater mortgaged properties. Staff does not expect additional pressures on foreclosures (from current levels) from the sluggish recovery in the labor market, since it projects a gradual improvement on that front.

United States: Selected Issues
Author: International Monetary Fund