House price history, biased expectations, and credit cycles: The role of housing investors

Abstract

Abstract Using the Michigan Survey, I show that consumers' house price expectations depend upon the recent history of house price developments in their city of residence. Forecast errors are predictable: people systematically underestimate momentum and neglect mean reversion, remaining over‐optimistic for several quarters after a prolonged trend of house price growth, and vice versa. Housing appreciation also increases the share of consumers who believe that real estate is a good investment. Combining loan‐level data from Freddie Mac to regional measures of housing sentiment, I show that an exogenous shift in house price expectations leads to an increase in leverage on new mortgage originations. The effect is concentrated on investment properties and among prime borrowers in nonrecourse states.