Credit Expansion, Bank Liberalization, and Structural Change in Bank Asset Accounts

Abstract

This paper studies the links among credit supply expansion, commercial bank asset account structures, and the housing boom preceding the 2007-2009 financial crisis. We propose a real business cycle model with a housing market and financial intermediaries (banks) subject to leverage constraints. In our model, banks channel funds to firms for production and provide collateralized loans to mortgage borrowers; thus, banks determine their asset account structures endogenously. We show that a credit supply expansion to banks can account for four key facts that characterize the housing boom: (1) an increase in real house prices; (2) an increase in the mortgage-to-GDP ratio; (3) a decrease in the real mortgage interest rate; and (4) an increase in the ratio of mortgages to firm loans in commercial bank asset accounts. In our model, a credit supply expansion to banks can also generate a boom-bust cycle through the collateral value channel via mortgage borrowers. Asset-side bank regulations that reduce excessive mortgage issuance during a credit boom can help to dampen the subsequent economic downturn.