Collateral Damage: Refinancing Constraints and Regional Recessions

Abstract

In the current structure of the U.S. residential mortgage market, a decrease in property values may make it very difficult for homeowners to refinance their mortgages to take advantage of declining interest rates. In this papr, we show that this form of collateral constraint has greatly reduced refinancing in statds with depressed property markets. We outline the interaction between regional recessions and refinancing constraints. WHEN ADVERSE ECONOMIC SHOCKS cause property values in a region to decrease, the damage to the collateral makes it difficult or impossible for some homeowners to obtain new mortgages. In the recent period, this has meant that homeowners in economically depressed regions have been unable to refinance their mortgages to take advantage of declining interest rates. This inability to refinance has further economic impacts on the region through lowering the wealth and the discretionary income of local homeowners, thereby deepening the regional recession. While the possible link between regional declines in property values and refinancing activity has been understood for some time (for example, Monsen 1992), the subject has received very little empirical attention. We provide the first quantitative assessment of the impact of constraints arising from regional property market dynamics on refinancing activity. To accomplish this, we use a new data set on more than thirty-five thousand individual mortgages. The sample consists of all mortgages serviced by Chemical Bank with originations between June 1989 and May 1992.

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