An Empirical Analysis of Real Estate Lending and Bank Failures: 1863-2012

Abstract

As demonstrated during the financial crisis of 2007-8 and several other times throughout history, bank failures can pose a threat to financial system stability and broader economic growth. The importance of real estate lending to banks’ financial viability and the relationship between real estate price swings and specific financial crises throughout American history has been amply demonstrated. In this paper we examine the historical relationship between banks’ real estate portfolios and subsequent bank failures using a novel, long-term dataset ranging from 1863 to 2012. We examine banks’ real estate loans, banks’ total assets and bank failures to test for a relationship between banks’ real estate lending and subsequent bank failures. Using the methodology of Pesaran and Shin (1999) and Pesaran et al. (2001), we conduct an Autoregressive Distributed Lag (ADL) “bounds test” to test for a long-run relationship between real estate loans and bank failures. We find evidence of a relationship between banks’ real estate loans as a percentage of total assets and failures in subsequent years.