Regulating Household Leverage

93 Pages Posted: 3 Oct 2017 Last revised: 10 Jan 2019

Date Written: January 8, 2019

Abstract

This paper 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 percent of the affected market completely and reduced leverage for another 20 percent of remaining borrowers. This reduction in quantities is much greater than would be implied by plausible demand elasticities and is difficult to reconcile with a frictionless view of credit markets. 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

JEL Classification: G18, D14, D18, E60, R30

Suggested Citation

DeFusco, Anthony and Johnson, Stephanie and Mondragon, John, Regulating Household Leverage (January 8, 2019). Available at SSRN: https://ssrn.com/abstract=3046564 or http://dx.doi.org/10.2139/ssrn.3046564

Anthony DeFusco (Contact Author)

Northwestern University - Kellogg School of Management ( email )

2211 Campus Drive
Evanston, IL 60208
United States

HOME PAGE: http://www.anthonydefusco.com

Stephanie Johnson

Northwestern University - Department of Economics ( email )

2003 Sheridan Road
Evanston, IL 60208
United States

John Mondragon

Northwestern University ( email )

Evanston, IL 60208
United States

Register to save articles to
your library

Register

Paper statistics

Downloads
153
rank
186,876
Abstract Views
789
PlumX Metrics