Banking, real estate markets and macroprudential policy: Quantitative studies and empirical support

This dissertation studies frictions in the lending market that generate overlending and lax lending standards. Chapter 2 develops a quantitative model to study two frictions: 1) limited liability and 2) banks failing to internalize that their credit decisions alter the pool of borrowers faced by other banks, which is more pronounced in competitive lending environments. These frictions amplify the effects of economic fluctuations. I show that macroprudential policy tools, including capital requirements and taxes on banks' lending and borrowings, can encourage banks to screen more and should be state-contingent. I then gather panel data from the U.S. mortgage market to study the effect of competition on mortgage lending standards. I find that more competitive lending environments are associated with lower lending standards, which supports the model's conclusions. Moreover, I find that this relationship changes with the supply elasticity of housing.;Chapter 3 presents a quantitative model that incorporates two frictions: 1) limited liability, and 2) imperfect information about the persistence of asset price growth, which generates incorrect but rational lender beliefs. I calibrate the model to match recent credit boom-bust episodes and study which patterns of real estate price growth could serve as early warning indicators of a crisis. I then propose a Value-at-Risk rule to implement capital requirements. Capital requirements should be state-contingent and lean against lenders' beliefs by tightening after periods of asset price growth. However, the relationship between asset price growth and financial risk is not monotone, and this should be incorporated in the setting of policy and interpretation of early warning indicators.;In Chapter 4, I create a new Metropolitan Statistical Area (MSA) level database to test the role of lender beliefs about housing prices and borrower incomes on mortgage lending standards. I employ a new proxy---banks' local branching decisions---to capture lenders' beliefs. I find that banks opening new branches in an MSA also lower their denial rates on mortgage applications associated with properties in that MSA. Moreover, I find that banks reacting to positive changes in home prices or borrower incomes by more rapidly expanding their branch network also approve more mortgage applications.