House hold auto finance

The Role of Collateralized Household Debt in AbstractMarket innovations following the financial reforms of the early 1980s relaxed collat-real constraints on household borrowing. The present paper examines the contributionof this development to the macroeconomic stabilization that occurred shortly thereafter .The model combines collateral constraints on households with heterogeneity of thriftin a calibrated general equilibrium setup. We use this tool to characterize the businesscycle implications of lowering required down payments and rates of amortization fordurable goods purchases as in the early 1980s. The model predicts that this relaxationof collateral constraints can explain a large fraction of the actual volatility decline inhours worked, output, household debt, and household durable goods purchases.Gadi Barlevy and Richard Suen provided insightful comments on earlier drafts of this paper .

1 Introduction

This paper examines the implications of the nancial reforms in the early 1980\'s for macroe-conomic volatility . The market innovations that followed the Monetary Control Act of 1980and the Garn-St. Germain Act of 1982 relaxed collateral constraints on household debt . Thewell-known decline in macroeconomic volatility occurred a short time after these reforms.Because this stabilization was particularly dramatic for residential investment, Stock andWatson (2002, 2003) suggest these reforms as one of its sources. An examination of thebehavior of household debt, reported below, supports such a link. Debt starts to acceler-ate at about the same time that macroeconomic volatility drops, and its standard deviationgoes down more than most key aggregates\'. Additionally, debt is strongly correlated withhours worked until the early 1980\'s, and much less so afterwards. Microeconomic evidencealso indicates a connection between labor supply and household debt. Using Canadian andItalian data, Fortin (1995) and Del Boca and Lusardi (2003) found that the labor supplyof married women increases with their households\' mortgage debts.

Taken together, thisevidence motivates us to explore the connection between collateralized household debt, laborsupply, and macroeconomic volatility using a quantitative general equilibrium model.The model combines trade between a patient saver and an impatient borrower with re-alistic features of most household loan contracts in the U.S.|a required down payment andrapid amortization. In equilibrium, the borrower has no nancial assets. When expand-ing purchases of home capital goods, the borrower must increase labor supply to financedown payments. The higher labor supply persists because of debt repayment . Relaxingthe collateral constraints|by reducing the down-payment rate or extending the term of theloans|weakens the link between durable purchases, debt, and hours worked; and therebyresults in lower aggregate variability.This paper follows Krusell and Smith (1998) in considering the cyclical implications ofheterogeneity in thrift interacting with a borrowing constraint|which in their frameworkis a xed zero-debt limit. In their economy\'s equilibrium, the limit practically disconnectsa large fraction of agents from the capital market. Krusell and Smith did not introduceendogenous labor in this economy.

We conjecture that such a modification would not changeaggregate behavior significantly since, with standard preferences, a constrained householdkeeps hours worked constant.1 In contrast, the collateral requirement in our frameworkamplifies constrained households\' labor fluctuations by linking hours worked with durablegoods purchases.1We return to this point in Footnote 11 .1In the present paper, home capital plays a dual role for households, as collateral for loansand as an intrinsically valued good, just as market capital plays a dual role for firms inKiyotaki and Moore (1997). Endogenous transmission mechanisms arise in both setups . InKiyotaki and Moore, an exogenous shock that increases net worth of a credit-constrainedrm raises its investment. Iacoviello (2004) develops a model where this type of mechanismalso amplifies credit-constrained households\' demand for goods. In the present framework,the transmission mechanism works through labor supply of credit-constrained households.We stress the role of collateral constraints by first using standard preferences and produc-tion possibilities, subject to exogenous productivity shocks. With this specification, outputvolatility depends primarily on the variance of the productivity shocks|as in the basic RBCmodel|because inputs vary relatively little. Hence, relaxation of the collateral constraintsreduces output\'s volatility modestly in spite of a substantial stabilization of hours worked.

Following King and Rebelo (2000), we then introduce preferences and production possibilitiesthat reduce the size of the exogenous shocks consistent with a given volatility of output. Thisversion of the model predicts that relaxing collateral constraints does substantially reducemacroeconomic volatility.Models with home production also address the cyclical interaction of household capital withhours worked. In those models, comovement depends on the technological role assignedto home capital . Rupert, Rogerson, and Wright (2000) point out that home productionby itself should not generate a link between home capital and labor supply under perfectcapital markets. Fisher (2001) incorporates a mechanism by which home capital improvesthe efectiveness of hours worked in the market. This setup generates a positive comovementbetween home capital and labor supply by technological means. In our framework, theinteraction arises from nancial factors.The remainder of this paper proceeds as follows . In the next section, we discuss thehistory of household loan markets and their reforms . In Section 3 we present evidence on thecyclical behavior of household debt and its association with the decline of macroeconomicvolatility. Section 4 presents the borrower-saver model, and in Section 5 the model\'s steadystate is used to analyze long-run responses to financial market reforms.

Section 6 buildsintuition by analyzing the borrower\'s labor supply decisions in partial equilibrium. Thequantitative results from calibrated versions of the model are reported in Section 7, and A Short History of Household Credit Markets We present here a brief history of household credit markets to provide a context for ouranalysis. In this section and in the rest of the paper we abstract from unsecured debt .According to the Survey of Consumer Finances, homes and vehicles collateralized 85 percentof total U.S. household debt in 1962 and almost 90 percent in 2001 .2Prior to the Great Depression, typical mortgage payments were only interest, and home-owners renanced their loans\' principles every few years . Semer et. al. (1986) report that firstmortgages had low loan-to-value ratios, but second and third mortgages with higher interestrates were common. For other household durable goods, a multitude of finance companiesprovided installment credit through retailers. (Olney (1991)).The Great Depression and its aftermath a ected these two segments of the householdlending market quite differently. Federal involvement in the mortgage market became mas-sive, while other household credit was regulated much less . Defation during the depressionperiod eroded housing values without aecting nominal balances due at maturity, so manyborrowers were unable to nd lenders to renance their loans. The resulting defaults mo-tivated the Hoover and Roosevelt administrations to exercise greater federal control overmortgage lending.

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