Propagation of House Price Shocks through the Banking System

This paper analyzes the propagation of house price shocks through the U.S. banking system. Although only roughly 30 percent of the mortgages that originated between 2000 and 2005 were retained on the banks' balance sheets, I find empirical evidence that exogenous negative house price shocks impacted the banks' balance sheets. Between 2006 and 2010, banks that faced a larger drop in their capital-to-assets ratio induced by exogenous house price shocks contracted the supply of new mortgages by more. Besides the propagation of house price shocks through the banks' balance sheets, the same shocks are also propagated across regions since more affected banks contract the credit supply even in areas where economic conditions didn't deteriorate. The drop in the credit supply by the banking system was attenuated by the presence of shadow banks, which face less strict regulatory constraints. The overall credit supply for new home purchases contracted by 5 percent more in counties with a higher presence of distressed banks (10th percentile) than in counties with a lower presence of affected banks (90th percentile). In terms of refinancing loans, the contraction is 12 percent higher in the most affected counties.