Cheap Credit, Collateral and the Boom-Bust Cycle (Job Market Paper)
This paper proposes a model of booms and busts in housing and non-housing consumption driven by the interplay between relatively low interest rates and an expansion of credit, triggered by further decline in interest rates and relaxing collateral requirements. When credit becomes available, households would like to borrow in order to frontload consumption, and this increases demand for housing and non-housing consumption. If the increase in the demand for housing translates into an increase in prices, then credit is fueled further, this time endogenously, both because of the wealth effect (the existing housing stock is now more valuable) and because housing can be used as collateral. Because a lifetime budget constraint still applies, even in the absence of a financial crisis, the initial expansion in housing and non-housing consumption will be followed by a period of contraction, with declining consumption and house prices. My mechanism clarifies that boom-bust dynamics will be accentuated in regions with inelastic supply of housing and muted in elastic regions. In line with qualitative predictions of my model, I provide evidence that differences in regions' elasticity of housing and initial relaxation of collateral constraints can explain most of the 2000-2006 boom and the subsequent bust in house prices and consumption across US counties. Quantitative evaluation of the model shows that reversal in the initial relaxation of collateral constraints is important in explaining the sharp decline of house prices and consumption. However, the model shows that most of the decline would have happened even without a reversal in the initial expansion of credit, albeit over a longer period of time.
The Value of Political Connections in the United States, joint with Daron Acemoglu, Simon Johnson, James Kwak and Todd Mitton (coming soon)
The announcement of Timothy Geithner as President Obamas nominee for Treasury Secretary in November 2008 produced a cumulative abnormal return for Geithner- connected financial firms of around 15 percent from day 0 (when the announcement was first leaked) to day 10. Using synthetic control method as well as OLS, we find a quantitative effect that is comparable to standard findings in emerging markets with weak institutions, and much higher than previous studies have found for the United States or other relatively rich democracies. The results hold across a wide range of robustness checks, including when we control for how much firms were affected by the financial crisis,. There were subsequently abnormal negative returns for connected firms when the news broke that Geithner’s confirmation might be derailed by tax issues. Since the Geithner nomination announcement, policy has been supportive of the financial services sector and Geithner-connected firms have continued to show positive cumulative abnormal returns, but there is no compelling evidence that Treasury implemented the exact form of favoritism implied by the stock market reaction. Our results pick up market expectations and the perceived value of connections at a moment of intense financial crisis, rather than how policy was subsequently designed or implemented.