How Do Foreclosures Exacerbate Housing Downturns?

45 Pages Posted: 3 Sep 2019 Last revised: 18 Feb 2022

See all articles by Adam M. Guren

Adam M. Guren

Boston University - Department of Economics

Timothy McQuade

Stanford University

Date Written: August 2019


This paper uses a structural model to show that foreclosures played a crucial role in exacerbating the recent housing bust and to analyze foreclosure mitigation policy. We consider a dynamic search model in which foreclosures freeze the market for non-foreclosures and reduce price and sales volume by eroding lender equity, destroying the credit of potential buyers, and making buyers more selective. These effects cause price-default spirals that amplify an initial shock and help the model fit both national and cross-sectional moments better than a model without foreclosure. When calibrated to the recent bust, the model reveals that the amplification generated by foreclosures is significant: Ruined credit and choosey buyers account for 25.4 percent of the total decline in non-distressed prices and lender losses account for an additional 22.6 percent. For policy, we find that principal reduction is less cost effective than lender equity injections or introducing a single seller that holds foreclosures off the market until demand rebounds. We also show that policies that slow down the pace of foreclosures can be counterproductive.

Suggested Citation

Guren, Adam M. and McQuade, Timothy, How Do Foreclosures Exacerbate Housing Downturns? (August 2019). NBER Working Paper No. w26216, Available at SSRN:

Adam M. Guren (Contact Author)

Boston University - Department of Economics ( email )

270 Bay State Road
Boston, MA 02215
United States


Timothy McQuade

Stanford University ( email )

Stanford, CA 94305
United States

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