Credit Expansion And Real Estate Bubbles Formation: Theory Models And Empirical Study

Real estate is a typical capital-intensive industry, the business activities require substantial funding support. Behind the funds, banks often permeated with the shadow. This paper first inspected the classic case of real estate bubbles happened in the past 20 years around the world, we found that both in the countries which use capital market as the main means of financing like United States, or the countries which use banks as the main financial system like Japan, or the newly industrialized countries which use the foreign investment as the main growth The driving force such as East Asia countries, in the formation process of real estate bubbles, shows that it is highly relevant between the credit expansion and real estate bubbles, that is, accompanied by rising real estate prices (or even rapidly rising), bank sector increased the credit amount to the real estate sector significantly. Based on this phenomenon, three closely related issues are proposed in this paper, and from these three issues` derivation we outlined the whole research framework.The first problem is what is the role does bank actually played in the process of real estate bubbles from small to large? If we can prove that in the process of formation of real estate bubbles, bank has played an important role, then, how much such is this influence?The second problem is that along with the rising of real estate prices, why does commercial banks ignored the growing risk to the real estate industry and increases its credit to real estate sector? Is this because commercial banks failed to assess their credit risk, or they can not make the right credit decision for other reasons?The third problem is closely related with the first two issues, namely the one hand, the real estate prices is continuous rising, on the one hand, bank credit to the real estate industry is continuous expanding, Who is affected whom between the two? This role is one-way or two-way? If it is a two-way street, then what is the mechanism of the interaction?The first question is actually refers to the determining factor of real estate prices, answer this question required inspection the partial equilibrium of real estate market. Chapter 3 of this paper will complete this work.Firstly, we analyzed the determining factors of real estate prices, on the basis of this, we described the Capital Chain character of the real estate industries from the perspective of funds, pointed out that there is a umbilical contact between the real estate business and the commercial banks. Banks provided sufficient financial support for the ever-expanding real estate prices until the bubbles generated.For in-depth analysis of this mechanism, we have introduced the Allen & Gale (2000) model and made a expansion to the model. In the model we discussed the different optimal choice of investors before and after the in bank is introduced and contrasted these two equilibriums, The results showed that the bank's intervention led to an agent investment problem which makes investors have possibility and incentive of shifting the risk, because the existence of the risk shifting, investors will ignore the investment risks and be willing to borrow more funds from bank for investment in real estate, resulting in Real estate bubbles.After proved that the bank credit play a important role of the real estate bubbles in theory, we analyzed the effectiveness of China's macro-control on real estate industries in recent years to prove the application of theory in China.The second question is actually about the interpretation of commercial bank`s credit expansion behavior, answering this question based on the inspection the partial equilibrium of bank credit marke. Chapter 4 of this paper mainly solved this question. We used information economics and game theory two kind of perspective to explain the credit expansion behavior of commercial banks. In each of angle, we started at the general framework and ended at China's special circumstances analysis.From the perspective of information economics, because of the less transparent of real estate market, the banks can not fully grasp the operating information, which make commercial banks in a disadvantage position, coupled with the short-sighted on the level of banking crisis and perverse incentive caused by institution such as deposit insurance and implicit guarantee by government, making bank systematically undervalued the risk of concentration on real estate loan, all of this led banks increase the line of credit to real estate sector.In China, commercial banks usually have a optimistical expectationin to the real estate industry under a particular the macroeconomic background, on the other hand, due to lack of information screening tool on corporate borrowers, the banks` credit decision-making have a strong reliance on collateral, as most real estate companies can provide a higher quality of the land mortgage, the bank makes credit rationing in a weakening of the real estate industry , Thus increasing the real estate sector line of credit.This paper, in terms of game theory, constructs a framework for bank-enterprise and bank-bank, suggesting that the expansion of banking into real estate is a rational equilibrium in the asymmetric market, no mater it is a single game or repeated games. This paper, assuming that the market is competitive and information is asymmetric, argues that banking in real estate tends to be expanded too in that an individual bank's action depends on other banks'action.In order to analyze the Chinese unique situation, this paper, studying the local governments, constructs a game theoretical framework for central government-local government and local government-bank. In the game of central government-local government, the latter one dominates the game in that the local governmental desire to invest in the real estate is strong and the commitment made by the central government to punish is not reliable, which make the real estate be possible to expand. In the game of local government-bank, banks, no matter small or big, are playing the negative role in real estate investment, which are affected by the local government. Therefore, the expansion in real estate is driven by banks'internal desires and external pressures.At the end of this part, this paper constructs a co-integration model to conclude the empirical findings of the effects of real estate price on banks'credit loans.The third question is mainly about the relationship between bank credit loan and real estate price, which should be answered through the study of equilibriums both in real estate market and in bank credit loan market. Chapter 5 in this paper addresses this subject, and basing on the mathematical models for real estate and bank credit loan markets, argues that the price of real estate is higher in the circumstance that bankers'own interests are involved than that in the circumstance that not .In order to analyze the mechanism in the relationship between loans and estate bubbles, this chapter, introducing analysis on bubble's economic effects and investors'transaction strategies, argues that there are feedbacks between banking loan expansion and real estate bubbles expansion, in a market full of mixed-rational participants.At the end of this part, this paper, by constructing VAR models, Granger causality test and IRFs, proves that there is a positive relationship between expansion in banking loans and in real estate price. There is inter-causality between them.The main innovations of this paper are listed as the following.I This paper analyzes the function of banks in the real estate bubbles, and applies model (Allen, Gale, 2000) to Chinese case. The original model assumes that investment is all from investor's own funds or from bank loans. This paper assumes that investment is partly from investor's own funds and from bank loans. The findings suggest that the original model is a special case as for this paper's model.II This paper, basing on the analysis of loans and estate price, argues that there are feedbacks in estate bubbles, real estate and banks when combining bubble feedback mechanisms together, which enriches the bubbles theories to some extent. VAR approach adopted in this paper is also rare in the research of real estate.III The main traditional research work seldom concludes banking loans into the analytic framework while addresses the function of banks in real estate. This paper tries to make a change, and constructs an analytic framework from universal situation to Chinese features, in terms of information economics and game theory.