Do Asset Price Bubbles have Negative Real Effects?

Abstract

In the recent recession and current economic recovery, policymakers have supported asset prices in the U.S. treasury and mortgage markets, expecting that improvement in the balance sheet of banks will lead to more commercial lending. In general, we document that increases in housing prices in a bank’s deposit base lead banks to decrease commercial lending. Further, we find that a one-standard deviation increase in housing prices is associated with a 10.3 percentage point decrease in investment of borrowing firms and a 4.2 percentage point decrease in leverage. These results suggest that when asset prices increase in one sector (such as the housing market), banks may respond by reallocating capital away from other sectors (such as commercial lending) towards the supported sectors.

Keywords: Bank Loans, Housing Shocks, Investment Policy, Leverage

JEL Classification: G21, G31, G32