Financing Competitors: Shadow Banks' Funding and Mortgage Market Competition

Abstract

Using novel shadow bank funding data that is linked to downstream loan-level mortgage data, I find that shadow banks that originate half of the mortgages in the U.S. are predominately funded by their competitors in the loan market: traditional depository banks that originate the same types of loans in the same regions. Empirical evidence suggests that banks have market power in the upstream market for shadow banks’ funding, which in turn softens competition in the downstream mortgage origination market. To better understand how relationship lending in the upstream market affects competition in the downstream market, I build a quantitative model, which incorporates the forces that I empirically document. The calibrated model shows that banks’ upstream market power significantly reduces mortgage lending volume and consumer surplus. These costs are largely borne by consumers in more concentrated markets, implying that shadow bank competition is least useful to the consumers who would benefit most from it. Lastly, I use the model to show that limited regulatory interventions could substantially increase downstream competition as would technological developments – such as faster GSE loan purchase program - which would reduce shadow banks’ reliance on their competitors.

Keywords: Intermediaries, competition, shadow bank, warehouse lines, mortgages

JEL Classification: G2, G5, L1, L5