Abstract
Not only did the collapse of housing prices in the aftermath of the U.S. subprime mortgage crisis of 2008 worsen the balance sheet positions of the banking sector, but it also led to a “bank run” in some cases such as the collapse of Lehman Brothers in September 2008. We develop a theoretical model featuring household debt (mortgages) and banking sector frictions. We show that mortgage risks can potentially lead to a bank run equilibrium. Such an equilibrium exists since mortgage risks reduce the liquidation prices of bank assets. We further show that mortgage market regulations such as loan-to-value requirements reduce the likelihood of bank runs.
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