Local financialization, household debt, and the great recession

Abstract

To test the relationship between local financial sector activity and household borrowing, I exploit the credit-supply shock that occurred prior to the Great Recession as a plausibly exogenous source of variation in borrowing behavior. Using a difference-in-differences approach I find that per-capita indebtedness increased by several thousand dollars—approximately 10%—more in states with a large local financial sector during the housing market boom. A similar positive relationship between financialization and indebtedness holds at the county level. These results suggest the growing influence of local financial markets as a fundamental cause of the Great Recession.