Securitization, housing market and banking sector behavior in a Stock-Flow Consistent model

Olimpia Fontana and Antoine Godin

This paper focuses on the different balance sheet management behavior of private banks and worker households, when assets are market-based. We take into consideration the securitization process, through which mortgage lending of households are converted into tradable securities that are demanded by investment banks in order to make profits. The demand of deposits by speculative households and realized capital gains on selling of mortgage-backed securities in the secondary market produce an inflation balloon in security markets, although we apply Basel III agreements on private banking behavior. We find that banks have active management of their balance sheets, this gives rise to a pro-cyclical leverage ratio, which is coherent with empirical evidence from the private banking sector. The model behaves well also with respect to the behavior of indebted households, that is the leverage of workers is countercyclical, as in Adrian and Shin (2010). These results are coherent with the recent financial crisis in U.S., as the evidence suggests that it has been a finance-led crisis and not a households-led crisis (Eatwell et al., 2008).