Regulating Household Leverage

Abstract

This article 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% of the affected market completely and reduced leverage for another 20% of remaining borrowers. This reduction in quantities is much greater than would be implied by plausible demand elasticities and indicates that lenders responded to the policy not only by raising prices but also by exiting the regulated portion of the market. 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.

The Strategic Response of Banks to Macroprudential Policies: Evidence from Mortgage Stress Tests in Canada*

“…They also point out that macroprudential policy assessment should take into account the strategic responses of the agents affected. DeFusco et al (2019) study the impacts of the Dodd-Frank "Ability-to-Repay" rule in the US mortgage market. 5 The rule incentivized lenders to qualify borrowers using DTI restriction because otherwise the cost of origination would be higher.…”

A day late and a dollar short: Liquidity and household formation among student borrowers

“…First, a body of work examines the determinants of household formation, both generally (e.g., Paciorek, 2016) and among young adults (Bhutta, 2015;Martins and Villanueva, 2009). The most related studies demonstrate the importance of liquidity and the availability of credit (Campbell and Cocco, 2003;DeFusco, Johnson, and Mondragon, 2017;Gorea and Midrigan, 2017;Sufi, 2011, 2015) and indicate that down payment constraints bind for many young households (Engelhardt, 1996;Fuster and Zafar, 2016;Berger, Turner, and Zwick, 2016). Other work finds that consumer debt, and sometimes specifically student loan debt, reduces formation; however, these studies generally attempt to compare individuals who are similar on all dimensions except for their liabilities and thus focus only on the potential negative effects of debt (Bleemer et al, 2014 andMezza et al, 2016;Dettling and Hsu, 2017;Chiteji, 2007).…”

Leverage Regulation and Market Structure: A Structural Model of the U.K. Mortgage Market

“…Prominent examples include risk‐weighted minimum capital requirements for lenders and limits to loan‐to‐income (LTI) and loan‐to‐value (LTV) for borrowers (Acharya, Engle, and Pierret (2014), Behn, Haselmann, and Wachtel (2016a), Jiménez et al. (2017), DeFusco, Johnson, and Mondragon (2020)). While there is relatively wide agreement on the necessity of such measures, the design of lender‐ and borrower‐based leverage regulations and their implications for the allocation of credit have been subject to debate.…”

“…Finally, I use the estimated model to explore possible interactions between capital requirements and limits to household leverage that have recently been discussed and implemented in some countries (Consumer Financial Protection Bureau (2013), Bank of England (2014), Acharya et al. (2020), DeFusco, Johnson, and Mondragon (2020)). I introduce a maximum LTV limit that removes from borrowers' menu all mortgages with leverage larger than 90%, both in an economy with risk‐weighted capital requirements and in a counterfactual economy with homogeneous capital requirements (as was the case before the financial crisis under Basel I).…”

“…My work also speaks to an alternative set of borrower‐based macroprudential policies that have been implemented in several countries since the global financial crisis (Hanson, Kashyap, and Stein (2011), Cerutti, Claessens, and Laeven (2017)). Among others, DeFusco, Johnson, and Mondragon (2020) show that the Dodd‐Frank “Ability‐to‐Repay” rule in the United States reduced household leverage, by increasing the cost of originating high‐leverage mortgages, but with little effect on defaults, while Acharya et al. (2020) find that the introduction of LTI and LTV limits in Ireland led to reallocation across households with limited aggregate effects.…”