Flashcards in Tutorium 3 Deck (19):
Two channels that can lead to a credit crunch
• lending channel: negative shock to the balance sheet of the lender —> lender lends less
• balance sheet channel: negative shock to the balance sheet of the borrower –> reduces his borrowing capacity
Diagrams (Y-axis interest rate, X-axis credit amount)
LC: supply shifts left
BSC: demand shifts left
Policy implications of the two lending channels
balance-sheet channel: repair the balance-sheet of the borrowers
—> tax cuts, subsidies, helicopter money (=creating new money)
Lending channel: repair the balance sheet of the lenders
—> bailouts, liquidity facilities
Definition: syndicated loan
large loan, that involves several lenders.
1 main lender, that searches for other lenders to participate
Compare investments of borrowers from healthy banks to investments of borrowers from unhealthy banks.
What problem may occur?
• borrowers may have access to other sources of finance
• this is easier for borrowers with:
a) good credit rating (reduces problems at asymmetric information)
b) large firms (better access to bond market)
Correlation btw. bank health and lending to a particular borrower? problems?
• it could be that unhealthy banks specialize in a certain type of firms, that were more negatively affected by the crisis and thus had to reduce their investments more
—> this positive correlation shows more the presence of a balance-sheet channel, not a lending channel
• Solution: check wether firm’s health differ depending on the health of the bank they are matched with
• the reason firms are investing less has nothing to with their banks health –> balance sheet channel
• Solution: check exposure of a bank to Lehman Brother, or to the subprime mortgage market
—> then: change in bank health not related to balance sheet of the borrowers
Consumer wealth —> consumption
what possible channels?
relationship btw. consumption and wealth expected to be positive
• direct wealth effect: you consume more bc. you are wealthier
• indirect wealth effect: a change in consumption affects the wealth of other people
• borrowing capacity: the lower your wealth, the less you are able to borrow and thus consume
Problems / solution when checking the correlation btw. consumer wealth and consumption
• change in own wealth and therefor consumption also affects the wealth of other people
• changes in housing wealth can be measured by changes in house prices regarding the elasticity of housing supply. The elasticity is driven by geographical factors —> changes in wealth (house prices) unrelated to changes in consumption
Marginal prospensity to consume for:
automobiles, durables, groceries
MPC is largest for cars, then durables, then groceries.
MPC = change in consumption per change of income
check the relationship btw. income and consumption depending on the wage level
check with lagged wealth (past wealth)
—> negative coefficient —> poorer hh. reduce their consumption more when their wealth decreases
MPC wealth change
implications for a recession
MPC is higher for poorer hh.
recessions, in which the wealth of poorer hh. is more affected will be severe, bc. of a larger decline in aggregate demand
More leverage hh. have a higher MPC.
High leverage —> more credit constrained
increase in wealth –> consume
house prices decreases —> hh. cuts spending
lower house price —> look less financially healthy
—> less ability to borrow
2 channels for increases in mortgage debts and house prices
• supply credit shock: lenders are willing to take more risk, innovation in financial intermediation, they expect house prices to keep increasing
• credit demand shock: borrowers have higher income
mortgage debt / income change from 2001 to 2005
ratio increased, suggesting that banks were willing to take more risk
• mortgage applications
• mortgage debt
• house prices
—> identify supply shock to explain mortgage credit expansion
• use denial rates (from before the shock) to describe unfulfilled demand
• compare changes in mortgage debt and house prices to change in denial rates
—> positive supply shock implies that mortgages and house prices increased more in areas with larger unfulfilled demand
When did mortgage default rates start to increase more than other types of debts?
Correlation btw. income growth and mortgage origination from 1990 to 2005
• Positive from 1990 to 2001 and negative afterwards
• Normally: higher income —> larger demand for housing
—> larger mortgage debt
• but: from 2001 to 2005, mortgage debt was higher in areas with lower income, consistent with an expansion in subprime mortgages
2001 - 2005 was after a crisis. This was followed by monetary policy.
Could the subprime mortgage expansion be the result of a lower interest rate, which especially affected the demand for mortgages of the poorer hh.?
Compare with the 1990-94 period (= past-crisis period with low interest rates):
• Did mortgage debt increase more in areas with higher initial denial rates?
—> Yes? the lower interest rate played a role.
—> No? The demand-based explanation is not valid.
Data 1990: High denial rates were followed by slow mortgage debt growth!
—> opposite to 2001