Financial Integration, Housing and Economic Volatility

Abstract

The Financial Crisis and the Great Recession that followed illustrate the sensitivity of the economy to a housing bust. This paper shows that financial integration both amplified the volatility of housing prices and economic sensitivity to housing-price shocks. We exploit variation credit-supply subsidies across local markets from the Government-Sponsored Enterprises to construct an instrument for housing price changes unrelated to fundamentals. Using this instrument, we find that a 1% rise in housing prices causes a 0.25% increase in economic growth. This effect is larger in localities more financially integrated with other markets through bank ownership ties. Financial integration thus raised the effect of collateral shocks on the economy, thereby increasing economic volatility.