Leaning Against Housing Booms Fueled by Credit

The aim of this paper is to empirically identify the state of the US housing market and to set state-dependent policy rules to smooth the housing cycle. I do so by estimating a three-state Markov-switching model of housing prices in which mortgage debt is the state-dependent variable. As a result, the housing market state might be classified as being in housing booms fueled by credit, normal, or implosion times. Second, I propose a state-contingent policy rule fed with the probabilities of being in each state. I apply such a rule to set a housing counter-cyclical capital buffer (SCCyB) and a time-varying home mortgage interest deduction rule. Finally, I show that such rules have the forecasting ability to predict the charge-off rates on real estate residential loans. The significance of this study is that it informs policymakers about the state of the housing market mechanically while it also provides a simple rule that allows the implementation of state-contingent macroprudential policy. Further, the structure of such a rule is general enough to be applied to other policy tools