Inefficient Regulation: Mortgages versus Total Credit

We study the impact of loan-to-value regulation (LTV cap) on supply and demand for unregulated debt that is used for home acquisition. In our setting, part of the home acquisition price is in the form of pre-existing debt exempt from the LTV cap. Due to variation in this debt, the introduction of the cap generated exogenous variation in the regulatory shock across dwellings. Our main finding is that households, especially constrained ones, start paying more for houses financed with more unregulated debt. Our difference-in-difference estimates suggest an implied price of equity of 8.6 percent, which is 6.2 percentage points higher than the prevailing mortgage rate. In the longer run, developers increase the supply of unregulated debt by about 50 percent. We corroborate our findings by aggregate evidence from 13 countries. Our results indicate that too narrowly defined LTV regulation may lead to higher borrowing costs and can in principle increase default risk rather than reduce it.