Credit-Induced Boom and Bust

Abstract

This paper exploits the federal preemption of national banks in 2004 from local laws against predatory lending to gauge the effect of the supply of credit on the real economy. First, the preemption regulation resulted in an 11% increase in annual lending in the 2004-2006 period, which is associated with a 3.3% rise in annual house price growth rate and a 2.2% expansion of employment in the non-tradable sectors. These effects are followed by a sharp decline in subsequent years. Furthermore, we show that the increase in the supply of credit reduced delinquencies during the boom years but increased them in bust years.

Keywords: Great Recession, subprime, credit supply, credit expansion, household leverage, household debt, preemption rule

JEL Classification: E20, E30, E51, G28