Credit Supply and the Housing Boom

We present a model of housing with collateral constraints on both on borrowers and lenders. The constraint on the borrowers corresponds to the usual collateral requirement on the purchase of new houses that has been extensively studied in the literature. The contribution of our analysis is to study constraints on the supply of credit, modeled as limitations in the share of mortgages that lenders can hold in their portfolios. These limits are motivated by risk weighted capital requirements on commercial banks, as well as minimum asset quality restrictions on large institutional investors. The analysis begins with a simple stylized model to understand the implications of transitioning to higher levels of credit supply. To quantify the macroeconomic effects of credit supply expansions we embed borrower and lender constraints into a rich dynamic model, calibrated using evidence on the expansion of off-balance sheet vehicles and market-based funding by financial intermediaries, as well as micro (Survey of Consumer Finances) and macro data (Flow of Funds, NIPA). Our results suggest that the housing boom which preceded the Great Recession was due to a progressive loosening of lending constraints in the residential mortgage market. This view is consistent with a number of empirical observations, such as the rapid increase in house prices and household debt, the stability of debt relative to collateral values, and the fall in mortgage rates. These empirical facts are difficult to reconcile with the popular view that attributes the housing boom to a loosening of borrowing constraints associated with lower collateral requirements.