Shadow Bank run, Housing and Credit Market: The Story of a Recession

This paper proposes a DSGE model with bank runs which improves Gertler and Kiyotaki (2015) to assess the impact of housing and credit markets in financial instability and shadow banking activities. This paper illustrates that a negative TFP shock is amplified by macro-financial and macro-housing channels through household’s balance sheet, bank’s balance sheet and liquidity channels. If the shock makes the shadow banking system insolvent, two equilibria, no-run and run equilibrium, coexist. In this view, run is a sunspot coordination failure; if households receive a negative signal from fundamentals and stop rolling over deposits to the financial sector, banks are not able to fund their losses by new deposits. So they are forced to liquidate their assets at an endogenous fire sale price. The main finding of this paper is that the model with housing comprehensively details the consequences of economic crises, namely home price double-dip, the output downward spiral and lengthy recovery period. In addition, the paper indicates that macroprudential policy tools in the form of capital adequacy buffers and loan-to-value ratios can be helpful for eliminating bank-run equilibrium. They safeguard the economy against extreme busts and help mitigate systemic risks by insulating asset prices.