Disequilibrium rationing
The most clear cut example of disequilibrium rationing is the UK mortgage market in the 1970s and early 1980s. Up to 1983 UK mortgage finance was controlled by a cartel of building societies (mutual organisations). The existence of disequilibrium rationing in the United States is more controversial (Meltzer 1974; Hendershott 1981; Jaffee & Rosen 1979), though Kent (1987) cites 1966, 1969-70 and 1974-75 as periods when disequilibrium credit rationing might have been evident in the US economy. In the US a range of factors have been cited to explain the possibility of disequilibrium rationing. These include usury laws in some states (Ostas 1976), ceilings on pass book accounts-regulation Q (Swan 1973), and upper limits on mortgage interest rates set by the Federal Housing Association (Jaffee & Rosen 1978, 1979).
Kent (1980) presented a model of credit rationing in the US under imperfect competition. Equilibrium stopped short of the competitive outcome because of the rising marginal cost of financing mortgages from retail deposits, as total lending expanded. With fixed rate mortgages an increase in interest rates is only paid by new borrowers, but all depositors received interest rate increases. Thus lending stops short of competitive equilibrium when the supply of funds and mortgages have different elasticities. This was treated as dynamic rationing because the imperfect competition emerged out of temporary disequilibrium. In the UK, building societies also depended upon financing from retail deposits though debt was typically variable rate. Credit rationing occurred because the mutuals acted as a cartel with the objective of keeping mortgage interest rates low, thus generating excess demand.
Excess demand and disequilibrium credit rationing requires a means of allocating credit, either access via a mortgage queue and/or binding constraints on those that borrow. Dougherty & Van Order (1982) consider the case of an absolute constraint on the amount that an individual can borrow. In this case the user cost of owner occupation has an additional argument, the ratio of the shadow price of the borrowing constraint to the marginal utility of non-housing consumption. Thus the extra cost reflects the departure from optimality at the margin. It is also the case that if a maximum payment to income ratio forces a borrower into a corner solution then changes in real interest rates will not effect housing/mortgage demand, but changes in nominal rates will ease or tighten this constraint (Muellbauer & Murphy 1997). Thus mortgage credit rationing also argues for the use of nominal rather than real interest rates in mortgage demand equations.
Rationing raises the user cost of owner occupation and reduces housing/ absolute mortgage demand. Dougherty & Van Order also note that in the case of a binding loan-to-value constraint then the interest rate term in the user cost equation should be a weighted average of the mortgage interest rate and opportunity cost of equity in the property. This forgone rate of return reflects the marginal cost of mortgage finance, which is not likely to be effected by the household chosen loan-to-value ratio. This means that lenders cannot remove excess demand for mortgage credit by changing their underwriting rules (Nellis & Thom 1983). The marginal cost of mortgage debt remains constant and credit rationing will persist. Financial deregulation should ease or remove credit rationing, and the user costs of owner occupation, and real interest rates, become a more applicable specification in housing/mortgage demand equations.
Ortalo-Magne & Rady (1999, 2002) demonstrate theoretically how relaxing loan-to-value ratio requirements predicts the observed post-deregulation increases in house prices observed in the UK. Thus the research offers an explanation for the increase in borrowing post-financial deregulation and its subsequent fall, in addition to the co-movement in housing transactions and prices. As previously noted, a key feature in Ortalo-Magne & Rady compared to Stein (1995), is that they do not require liquidity constraints to be widely spread, so that in theory liquidity constraints persisting in a deregulated environment, for some borrowers, could still generate the noted effects.
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