Regulating Household Leverage

Anthony DeFusco, Stephanie Johnson and John Mondragon

The Review of Economic Studies, 2020, vol. 87, issue 2, 914-958

Abstract: This article studies how credit markets respond to policy constraints on household leverage. Exploiting a sharp policy-induced discontinuity in the cost of originating certain high-leverage mortgages, we study how the Dodd–Frank “Ability-to-Repay” rule affected the price and availability of credit in the U.S. mortgage market. Our estimates show that the policy had only moderate effects on prices, increasing interest rates on affected loans by 10–15 basis points. The effect on quantities, however, was significantly larger; we estimate that the policy eliminated 15% of the affected market completely and reduced leverage for another 20% of remaining borrowers. This reduction in quantities is much greater than would be implied by plausible demand elasticities and indicates that lenders responded to the policy not only by raising prices but also by exiting the regulated portion of the market. Heterogeneity in the quantity response across lenders suggests that agency costs may have been one particularly important market friction contributing to the large overall effect as the fall in lending was substantially larger among lenders relying on third-parties to originate loans. Finally, while the policy succeeded in reducing leverage, our estimates suggest this effect would have only slightly reduced aggregate default rates during the housing crisis.

Keywords: Household leverage; Financial regulation; Macroprudential policy; Mortgage markets (search for similar items in EconPapers)
JEL-codes: D14 D18 E60 G18 R30 (search for similar items in EconPapers)
Date: 2020
References: Add references at CitEc
Citations: View citations in EconPapers (65)

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Working Paper: Regulating Household Leverage (2017)
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