How Monetary Policy Shaped the Housing Boom

Between 2003 and 2006, the Federal Reserve raised rates by 4.25%. Yet it was precisely during this period that the housing boom accelerated, fueled by rapid growth in mortgage lending. There is deep disagreement about how, or even if, monetary policy impacted the boom. Using differences in exposure to the deposits channel of monetary policy, we show that Fed tightening induced a large reduction in banks' deposit funding, which led them to contract new on-balance sheet mortgage lending by 32%. However, this contraction was largely offset by substitution to privately-securitized mortgages, led by nonbank originators. Fed tightening thus induced a shift in the mortgage market away from stable, insured deposit funding toward run-prone and fragile capital markets funding. Consistent with this theory, privately-securitized mortgages reemerged in recent years as short-term interest rates rose