Do Financial Constraints Cool a Housing Boom? Theory and Evidence from a Macroprudential Policy on Million Dollar Homes
In this paper we seek to understand the role of financial constraints in the housing market and their effectiveness as a macroprudential policy tool aimed at cooling a housing boom. We exploit a natural experiment arising from the 2012 Canadian law change that restricts access to mortgage insurance (MI) to homes under one million dollars ($1M). Our empirical analysis is motivated by a directed search model that features auction mechanisms and financially constrained bidders. We model the MI regulation as a tightening of the financial constraint faced by a subset of prospective buyers. This prompts some sellers in the near $1M segments to strategically adjust their asking price to $1M, which attracts both constrained and unconstrained buyers. Competition between bidders dampens the impact of the policy on sales prices. Using transaction data from the Toronto housing market, we find that the limitation of MI causes a sharp bunching of homes listed at the $1M, with two-thirds of bunching coming from houses that have otherwise been listed below $995, 000, and the remaining from houses that have otherwise been listed above $1M. In addition, we find a smaller degree of bunching of the sales price at $1M, most of which comes from houses that would have otherwise been sold above $1M. Thus the MI cools down the targeted segment in the desired direction, although its impact is attenuated by heightened competition among bidders. Overall, our analysis points to the importance of strategic and equilibrium considerations in assessing the effectiveness of macroprudential policies.
Lu Han, Chandler Lutz, Benjamin M. Sand, and Derek Stacey