The Real Effects of Asset Market Bubbles: Loan- and Firm- level Evidence of a Lending Channel

Abstract

This paper studies how a shock to the financial health of the banking sector, caused by a decline in the asset markets, affects the real economy. The dramatic collapse of the land market in Japan in the early 1990s provides an ideal testing field. As Japanese banks have significant exposure to the real estate sector, this setting, along with a unique dataset of matched lending between lenders and borrowers, resolves difficulties in separating the economic impact of a loan supply shock from contemporaneous demand shocks. Two sets of results characterizing the transmission of the shock are presented. At the individual loan level, I show that banks with greater exposure to the real estate sector prior to the collapse have to reduce lending, after fully controlling for borrower characteristics that may affect loan demand. At the individual firm level, I find that firms’ fixed investment and stock market valuation are negatively associated with their top lender’s real estate exposure. The lending channel is economically important: the shock from the real estate market accounts for almost one-third of economic-wide contraction in bank lending to the manufacturing sector and accounts for about one-fifth of the decline in fixed investment and stock market valuation. JEL Classification: G21; C41