Laws governing the foreclosure process can have direct consequences for the costs of foreclosure and, therefore could affect lending decisions. We exploit the heterogeneity in judicial requirements across US states to examine their impact on banks’ lending decisions in a sample of urban areas straddling state borders. A key feature of our study is the way it exploits an exogenous cutoff in loan eligibility to government-sponsored enterprises (GSEs) guarantees, which shift the burden of foreclosure costs onto the GSEs. We find that judicial requirements reduce the supply of credit only for jumbo loans, which are ineligible for GSE guarantees, i.e., in the nonsubsidized segment of the market. Thus, while we find a significant effect on credit supply, the aggregate impact is muted by the indirect cross-subsidy by the GSEs to borrower-friendly states.

We examine the impact of banks׳ exposure to market liquidity shocks through wholesale funding on their supply of credit during the financial crisis using loan level data that best allow us to isolate supply-side effects. We find that banks that were more reliant on wholesale funding curtailed their credit significantly more than retail-funded banks. We also exploit the discrete fall in the liquidity of loans above the jumbo cutoff and show that this effect is significantly more pronounced for less liquid loans in line with a liquidity channel. We show that this result cannot be attributed to uneven shifts in demand. The negative relation between wholesale funding and the supply of credit is unique to the crisis episode.

A historical look at financial boom-bust cycles shows that pro-cyclicality in financial regulation is a common and recurring pattern. This paper shows that inefficient regulatory cycles can naturally arise when electoral concerns are introduced into a simple model of financial intermediation. We explore how financial innovations, public opinion and policymakers’ incentives shape financial regulation within this framework. We show that in the presence of incompetent politicians, competent politicians take regulatory risks to signal their competence. This amplifies the influence of public opinion on policy, leading to an ex ante inefficient pro-cyclicality in financial regulation.