This paper studies how credit markets respond to policy constraints on household leverage. Exploiting a sharp policy-induced discontinuity in the cost of originating certain high-leverage mortgages, we study how the Dodd-Frank “Ability-to-Repay” rule affected the price and availability of credit in the U.S. mortgage market. Our estimates show that the policy had only moderate effects on prices, increasing interest rates on affected loans by 10-15 basis points. The effect on quantities, however, was significantly larger; we estimate that the policy eliminated 15 percent of the affected market completely and reduced leverage for another 20 percent of remaining borrowers. This reduction in quantities is much greater than would be implied by plausible demand elasticities and suggests that lenders responded to the policy primarily by rationing credit. Finally, while the policy succeeded in reducing leverage, our estimates suggest this effect would have only slightly reduced aggregate default rates during the housing crisis.

Household leverage played a central role during the global financial crisis of 2007–2009.  As a result, the U.S. policy response to the crisis included many measures directly targeting household leverage. Some of these measures were ex-post, intended to mitigate the immediate fallout from the crisis by restructuring existing debt contracts or providing households with temporary debt payment relief. Other policies had a more ex-ante, macroprudential focus and sought to decrease the likelihood of future crises by curtailing risky lending practices and preventing households from becoming highly leveraged.