The last fifteen years have been marked by a dramatic boom-bust cycle in real estate prices, accompanied by economically large fluctuations in international capital flows. We argue that changes in international capital flows played, at most, a small role in driving house price movements in this episode and that, instead, the key causal factor was a financial market liberalization and its subsequent reversal. Using observations on credit standards, capital flows, and interest rates, we nd that a bank survey measure of credit supply, by itself, explains 53 percent of the quarterly variation in house price growth in the U.S. over the period 1992-2010, while it explains 66 percent over the period since 2000. By contrast, once we control for credit supply, various measures of capital flows, real interest rates, and aggregate activity collectively add less than 5% to the fraction of variation explained for these same movements in home values. Credit supply retains its strong marginal explanatory power for house price movements over the period 2002-2010 in a panel of international data, while capital flows have no explanatory power.

In this paper we have studied the correlations between house price changes and international capital flows, over the boom-bust period in the housing market from 2000-2010. We have argued that foreign capital flows into safe U.S. securities U.S. Treasury and Agency bonds played an important role in understanding the low-interest rates in the last decade and quantitatively account for all of the upward long-term trend in the U.S. net foreign liability position over this period. Many countries that saw large housing booms and busts attracted foreign capital, as witnessed by their large current account deficits. Much of this capital seems to have found its way into residential investment and mortgage credit extension.