The Unassuming Economist

From Atif Mian and Amir Sufi at VoxEU:

“Charles P. Kindleberger wrote that “asset price bubbles depend on the growth in credit”. This column looks at the acceleration of the US private label mortgage securitisation market in the US in the late summer of 2003, which disproportionately reduced the cost of financing by lenders that did not traditionally rely on deposit financing for mortgage lending. The sharp rise in lending in zip codes with greater exposure to such lenders generated a boom and bust in house prices. Easier credit also appears to have been a crucial ingredient in explaining bubble cities that experienced both house price and construction booms.

Charles P. Kindleberger, who was the world’s leading expert on financial crises, wrote that “asset price bubbles depend on the growth in credit” (Kindleberger and Aliber 2005). Nobel prize winner Vernon Smith described evidence from experimental settings showing that that the size of a bubble increased when individuals were allowed to borrow (Porter and Smith 1994). Economic theorists have taken this lesson to heart, writing down models in which easier credit helps fuel asset prices through an increase in speculative buying (Allen and Gorton 1993, Allen and Gale 2000).

A core idea in the theory of credit and bubbles is that easier credit allows optimists with high asset valuations to aggressively buy assets, and therefore boost the price (Geanakoplos 2010, Simsek 2013). Even if optimists form a small part of the overall population, easier credit can allow this small group to have a large effect on the market. Further, if the optimists suddenly lose access to credit, the price of the asset will collapse before more pessimistic individuals can be induced to buy the asset. As a result, fluctuations in credit availability increase the amplitude of fluctuations in asset prices.

Our recent study tests this idea, focusing on the boom and bust in house prices from 2000 to 2010 in the US (Mian and Sufi 2018). The study focuses on a natural experiment: the sudden acceleration of the private label mortgage securitisation (PLS) market in the late summer of 2003. The sudden rise in the PLS market, which was part of the broader global rise in shadow banking during this period, disproportionately reduced the cost of financing by lenders that did not traditionally rely on deposit financing for mortgage lending. The study shows that lenders who traditionally relied on non-deposit financing, such as CountryWide and Ameriquest Mortgage Company, suddenly boosted mortgage lending in the late summer of 2003, just as the PLS market accelerated.

To test the effect of this sudden increase in credit availability on the housing market, we exploit variation across geographic areas in the US in the location of these lenders as of 2002. Zip codes where lenders traditionally relied on non-deposit financing witnessed a sudden and large relative increase in mortgage lending just as the PLS market accelerated in 2003. Our study shows several results that suggest this is a clean experiment – the sudden and large expansion of mortgage lending in these zip codes was due to the acceleration of the PLS market, as opposed to some other factor such as a change in income prospects or beliefs about house prices among those living in these zip codes.”

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