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Whatever the causes of the boom, the result was what turned out to be a glut of housing, which, as people's beliefs about demand growth adjusted, led to historic declines in prices. The most immediate effect was a collapse in residential investment and large consequent declines in employment in construction and related sectors. The reduction in home owners' wealth as home prices declined, together with growing uncertainty about labor market prospects, caused household spending to slow beginning in mid-2007, and then declined outright in mid-2008. The dimming outlook for consumer spending also dampened business investment spending in turn and spread the employment slowdown beyond the residential construction sector. This, in turn, further dampened the consumer spending. These trends reduced prospects for, and increased uncertainty about, household incomes and firm revenues. As a result, households and firms are riskier, lending prospects than they were a couple of years ago, given the change in the overall macroeconomic environment. Note that surveys that ask lenders whether they have "tightened terms" in recent months do not really get at this question. Any given profile of borrower characteristics--income, balance sheet, and credit score, for example--is likely to translate into a riskier loan now, so banks are likely to have tightened qualification cutoffs even without any reduction in their risk appetite.

The antecedent of the contraction we are in was the boom in home sales, prices, and construction coming out of the last recession. Untangling the causes of that boom poses research challenges that will launch a thousand dissertations, I expect. The most plausible suspects at this point include financial innovation, regulatory laxity, accommodative monetary policy, and a global savings glut; but all worked through the expanding availability of mortgage credit. Even with favorable financing conditions, the increasingly leveraged purchases of homes would not have made sense without confidence--in hindsight misplaced confidence--in a continued upward path for home prices.