Abstract:

With ``2020 hindsight,'' the 2000s housing cycle is not a boom-bust but a boom-bust-rebound. Using a spatial equilibrium regression in which house prices are determined by income, amenities, urbanization, and supply, we show that long-run city-level fundamentals predict not only 1997-2019 price and rent growth but also the amplitude of the boom-bust-rebound. This evidence motivates our model of a cycle rooted in fundamentals. Households learn about fundamentals by observing ``dividends'' but become over-optimistic in the boom due to diagnostic expectations. A bust ensues when beliefs start to correct,  exacerbated by a price-foreclosure spiral that drives prices below their long-run level. The rebound follows as prices converge to a path commensurate with higher fundamental growth. The estimated model explains the boom-bust-rebound with a single shock and accounts quantitatively for the dynamics of prices, rents, and foreclosures in cities with the largest cycles. We draw implications for asset cycles more generally.

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Replication package: https://zenodo.org/record/7545542#.Y8cCi3bMJaQ

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