When homeowners experience house price inflation, their access to credit will generally increase. As a result, lending to less credit-worthy borrows can increase to an extent that is harmful to society (figure 1), without individual lenders bearing the full cost of higher debt levels.
It’s no surprise that those dynamics can apply in reverse when the economy weakens: as household incomes fall, the ability of borrowers to service debt is undermined, and defaults increase. This produces losses in the banking system and can trigger a fire-sale of housing, which compounds the downturn in house prices.