What Fuels the Boom Drives the Bust: Regulation and the Mortgage Crisis

IMF Working Papers, September 1, 2011

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Lightly regulated non-bank mortgage originators contributed disproportionately to the recent boom-bust housing cycle.
The market share of independent non-bank lenders increased in virtually all US counties during the boom.
Higher pre-crisis (as of 2005) market participation by independent non-bank lenders is associated with increased foreclosure filing rates at the onset of the housing downturn.
The relation between the pre-crisis market share of independents and the rise in foreclosure is more pronounced in less regulated states.
The market share of these lenders as of 2005 is a strong predictor of the severity of the housing downturn and the subsequent rise in unemployment.
Overall conclusion: more stringent regulation could have averted some of the volatility in the housing market during the recent boom-bust episode.

Data: comprehensive data on mortgage originations aggregated at the county level.
Identification strategy: exploit heterogeneity in the market share of independent lenders across counties as of 2005.
Estimation approaches: controls for counties' economic, demographic, and housing market characteristics using both parametric and semi-nonparametric methods.
Outcome measures: foreclosure filing rates, severity of housing downturn, and subsequent rise in unemployment.

County-level aggregation confirms market share growth of independent non-bank lenders occurred across virtually all US counties during the boom.
The association between independent-lender market share and foreclosure filing rates persists after careful control for county characteristics.
Effects are heterogeneous across states: the relation is stronger in less regulated states.

Pre-crisis market share of independent non-bank lenders predicts:
- Severity of the housing downturn.
- Subsequent rise in unemployment.
Implication: lender composition and regulatory intensity at the county/state level had meaningful macroeconomic impacts during the episode.

Findings lend support to the view that more stringent regulation of non-bank mortgage originators could have mitigated housing market volatility during the boom-bust episode.
Targeted regulatory tightening in lightly regulated jurisdictions may reduce susceptibility to foreclosure spikes and larger macroeconomic fallout in future housing cycles.

What Fuels the Boom Drives the Bust: Regulation and the Mortgage Crisis — ByJihad Dagher, Ning Fu — September 1, 2011