This paper studies how the collapse of the asset-backed securities (ABS) market during the financial crisis of 2007-2009 affected the supply of credit to the broader economy using a new dataset that describes unique interbank relationships within the credit union industry. This industry is important for consumer finance, and we find that ABS-related losses at correspondent credit unions are associated with a large contraction in the supply of consumer credit and hoarding of cash among downstream credit unions. We also find that this contraction in credit supply was concentrated among downstream credit unions that began the crisis with lower capital asset ratios and that it may have amplified the initial decline in house prices.

These results suggest that capital regulation might shape the ability of financial institutions to transmit securities price volatility onto the real economy. Most narratives broadly agree that the proximate cause of the 2007-2009 financial crisis centered around the collapse of the housing bubble in the United States. Mortgages and other loans were securitized into asset-backed securities (ABS), which were held on the balance sheet of banks and distributed widely throughout the financial system. Falling house prices and rising mortgage defaults then led to sharp declines in the price of mortgages and other types of ABS, igniting concerns about the liquidity and solvency of the banking sector (Brunnermeier (2009), Gorton (2009), Shleifer and Vishny (2011)). Less well understood, however, is the mechanism through which the decline in ABS prices might have affected the supply of credit to consumers and small businesses in the broader economy. There is already powerful evidence that household leverage during the boom in conjunction with falling house prices during the bust may have depressed consumer demand, helping to engender the relatively slow recovery in output growth, employment and consumption (Mian and Sufi (2011)). But the ABS-related balance sheet losses incurred by the financial sector may have also led to a fundamental post-crisis disruption in credit intermediation, contributing to the slow economic recovery and weak house price growth.