Creditor Rights, Collateral Reuse, and Credit Supply

Theories linking the reuse of collateral to financial instability have been influential in macroeconomics but empirical evidence on them is limited. I utilize a change to bankruptcy treatment of repo collateral to provide causal evidence that strengthened creditor rights increase credit supply and financial instability by increasing the reuse of repo collateral. Using novel hand-collected data linking dealers’ repledgeable collateral to their lending to mortgage companies, I find that dealers exposed to the change in bankruptcy treatment increased their repledgeable collateral – consistent with a money multiplier – and their credit supply to mortgage companies during the 2000’s housing boom and bust. I establish that increased dealer credit provision drove mortgage companies to increase originations and pivot toward risky products. I estimate that the expansion in credit increased originations by 9% and accounted for 38% of defaults on mortgages originated during 2005-2006, consistent with a financial accelerator channel of repo funding. I estimate the money multiplier of private-label mortgage collateral to be 4.5 times that of Treasuries, shedding new light on the previously unknown size of this repo money multiplier