Can Higher Federal Funds Rates Control Mortgage Lending

ed
During High Inflation and High House Prices
in Absence of Reserve Requirements?

iew
Mohammad Saiful Islam
University of Siegen, Siegen, Germany
Chair of Finance in Business Administration, esp. Digitalization
e-mail: mohammad.islam@uni-siegen.de

ev
Jascha-Alexander Koch (Corresponding Author)

r
University of Siegen, Siegen, Germany
Chair of Finance in Business Administration, esp. Digitalization

er
e-mail: jascha-alexander.koch@uni-siegen.de
pe
ot
tn

Funding: This research did not receive any specific grant from funding agencies in the public,
rin

commercial, or not-for-profit sectors.

CRediT authorship contribution statement: Mohammad Saiful Islam: Conceptualization,

Data curation, Methodology, Formal analysis, Software, Writing – original draft. Jascha-
ep

Alexander Koch: Conceptualization, Methodology, Validation, Supervision, Resources, Writing

– review & editing.

Declaration of Interest: None.

Pr

Data availability: Data will be made available on request.

This preprint research paper has not been peer reviewed. Electronic copy available at: https://ssrn.com/abstract=4757302
 Can Higher Federal Funds Rates Control Mortgage Lending
During High Inflation and High House Prices in Absence of Reserve Requirements?

ed
Abstract

iew
The U.S. is facing higher inflation since December 2020 along with higher house prices. After a sharp

increase, house prices have started to decline very recently even more drastically – reminding us of the

global financial crisis 2007–08. Rather late, from December 2021 onwards, the Fed started to increase the

Fed fund rate. However, it is unclear whether the Fed funds rate can control bank lending activities –

ev
especially, mortgage lending. Surprisingly, our results suggest that the Fed funds rate fails to control

mortgage lending during high inflation and high house prices in the absence of bank reserve requirements.

r
Key Words: Federal reserve funds rates, U.S. banks, inflation, house sales price, mortgage loan, bank

reserve requirements

JEL Classification: M4, G1, G21, G28

er
pe
1. Introduction

The spectacular rise of house prices during high inflation and the Covid-19 crisis has prompted the Federal

Reserve System (Fed) to respond with a higher Fed funds rate to control mortgage lending of banks. The
ot

median house sales price in the U.S. was USD 358,700 in September 2020 and increased to USD 479,500

in September 2022 (+33.68 %) and, then, dropped to USD 431,000 in June 2023 (-10.11 %) within only two
tn

quarters (Figure 1). The literature argues that there is a strong relationship between granting mortgage

credits and house prices so that a higher volume of mortgage credits will lead to higher house prices (Akçay
rin

et al., 2023). The house price bubble test even reveals an explosive housing price bubble during the Covid-

19 pandemic (Hansen et al., 2024). Moreover, the situation of a low Fed funds rate for a long period before

a sharp increase of house sales price reminds us of the starting of the global financial crisis 2007–08.
ep

The global financial crisis 2007–08 originated from excessive liquidity in the mortgage market due to a low

Fed funds rate for a long period and a subsequent large-scale mortgage market meltdown (Choi, 2013).
Pr

Experiences from the global financial crisis reveal that during the situation of a lower Fed funds rate and

higher house sales price, people judge investing in real estate as the best investment alternative expecting

increasing house prices in near future – which, in turn, will lead to massive default of mortgage borrowers

1
This preprint research paper has not been peer reviewed. Electronic copy available at: https://ssrn.com/abstract=4757302
 during a subsequent mortgage market meltdown (Choi, 2013). Mortgage borrowers even default willingly

when house prices drop below the outstanding loan. As a result, the supply of houses in the market further

ed
increases while the demand declines resulting in an even more severe decline of house prices (Choi, 2013).

The current situation of the U.S. economy seems to be even more vulnerable compared to the global financial

iew
crisis 2007–2008 due to some major changes that bear the potential of a new financial crisis in near future

(Sachs Realty, 2024). Currently, the U.S. economy and the mortgage market are under extreme pressure

due to the following reasons: First, the Fed funds rate is currently very high after being zero or near zero for

a long time during Covid-19 (Figure 1). Second, the economy is facing high inflation (Figure 1). Third, record-

ev
breaking booming house sales prices during Covid-19 (Figure 1) – even greater than in the period of the

global financial crisis – may have stimulated mortgage lending because of the previously low interest rates

r
due to low Fed funds rates – followed by house sales prices that have already started to decline significantly.

Fourth, while the Fed funds rate is quite high in the market at present, banks receive only low returns based

on low interest rates from fixed-rate mortgage loans being contracted during previous times of near-zero Fed

funds rates. Banks even have to pay higher interest rates on deposits so that depositors do not withdraw
er
pe
their money to invest somewhere else for a higher return. Finally, banks are incentivized to lend more money

of their deposits in an aggressive manner due to the lack of reserve requirements, which allows banks to

lend money without keeping a certain portion of deposits as regulatory reserve (Dinh, 2023, Albertazzi et al.,
ot

2024, Sachs Realty, 2024; Koch and Islam, 2024).

Figure 1: Movement of Fed funds rate, inflation, and house sales price
tn

500,000

450,000

400,000

350,000
8
300,000
rin

6
250,000

4 200,000

0
ep

-2
2011q3
2012q1
2012q3
2013q1
2013q3
2014q1
2014q3
2015q1
2015q3
2016q1
2016q3
2017q1
2017q3
2018q1
2018q3
2019q1
2019q3
2020q1
2020q3
2021q1
2021q3
2022q1
2022q3
2023q1

Fed funds rate (%)

House price (USD)
PCE inflation (%)
Pr

(Data sources: YCharts, 2024; FRED, 2023; Refinitiv Workspace, 2023)

Usually, a bubble in the housing market leads to subprime lending because favorable price expectations

decrease default concerns of lenders and they extend loans to riskier borrowers (Brueckner et al., 2012).

2
This preprint research paper has not been peer reviewed. Electronic copy available at: https://ssrn.com/abstract=4757302
 This might also have happened during the Covid-19 pandemic crisis which could have even more adverse

consequences than the last global financial crisis. House sales prices have already started to decline sharply

ed
– which might be a first warning signal. Therefore, it is important that the Fed is able to control the mortgage

lending market of U.S. banks by adapting the Fed funds rate – which is currently the only available key

iew
monetary policy instrument after the elimination of banks’ reserve requirements in March 2020.

We observe that mortgage loans make up the biggest portion (48%) of the loan portfolios of the U.S. banks

in our sample. During high inflation, the Fed increases the Fed fund rate as key monetary policy tool to control

money supply through all lending channels. If the Fed is not able to control mortgage loans during high

ev
inflation and high house prices, then, a considerable decline in house prices can lead to a new financial crisis

– just as happened in 2007. Thus, it is of utmost importance to find out about Fed fund rates’ effectiveness

r
to control mortgage loans (Dutkowsky and VanHoose, 2020) – especially during high inflation and high house

prices in combination with the new situation of having no reserve requirement, which formerly allowed for

er
controlling bank lending, impacting loanable funds (Fabiani et al., 2022).
pe
Some researchers have already turned towards the Fed funds rates’ impact on the U.S. economy (e.g.,

Evans and Robertson, 2018) – however, to the best of our knowledge, no academic paper has yet worked

on the impact of Fed funds rate on mortgage lending of U.S. banks in these current conditions of a noticeably

changed economic environment. Therefore, our paper addresses the research question of whether the Fed
ot

is able to control the mortgage lending market of U.S. banks by adapting the Fed funds rate – which is

currently the only available key monetary policy instrument after the elimination of banks’ reserve
tn

requirements.

The Fed relies on the Fed fund rate as the key measure to control banks’ lending activities. Higher Fed funds
rin

rates make borrowing more expensive, which leads to increased costs and reduced purchasing power of the

potential homebuyers. Thus, it seems quite reasonable to believe that higher Fed funds rates are able to

control, i.e., to limit or even reduce, mortgage lending activities. Of course, existing fixed-rate loans will not
ep

be affected because their interest rate is not dependent on Fed funds rate’s changes. However, new loans

with both fixed and variable rates become much more expensive and should, thus, be originated less often.
Pr

In addition to fewer newly originated loans, the existing portfolio is steadily shrinking because of loan

repayments. On balance, the amount of mortgage loans is expected to be reduced due to higher Fed funds

rates. Therefore, we hypothesize:

3
This preprint research paper has not been peer reviewed. Electronic copy available at: https://ssrn.com/abstract=4757302
 H1: A higher Fed fund rate can effectively control mortgage lending of banks.

ed
For testing this hypothesis, we apply ordinary least squares (OLS) and difference generalized method of

moments (GMM) on quarterly panel data from December 2020 to June 2023, which is the period of higher

inflation, higher house sales price, and Fed’s response of a higher Fed funds rate in the absence of reserve

iew
requirement.

2. Data and methodology

2.1 Data and variables

ev
Our study applies quarterly panel data of 40 insured U.S.-chartered commercial banks representing around

40 percent of the total consolidated assets of all 2,124 insured U.S.-chartered commercial banks (Federal

r
Reserve Statistical Release, 2023). Therefore, the Federal Deposit Insurance Coverage (FDIC) covers all

er
the banks under our study. Total consolidated assets of the banks in our sample vary from USD 1,216 million

to USD 2,465,234 million. The study covers 11 quarters from the last quarter of 2020 (December) to the

second quarter of 2023 (June). Both the PCE inflation rate and the median house sales price increased
pe
drastically during the sampled period of our study (YCharts, 2024; FRED, 2024).

Our study considers two dependent variables: (1) Mortgage loan to total loan (Mortgage Loan/TL) (Dutkowsky

and VanHoose, 2020; Albertazzi et al., 2024; Evans and Robertson, 2018): this represents the percentage
ot

of outstanding mortgage loans (after deducting installment payments and adding new mortgage loan

originations) of the total loans outstanding of a bank. Therefore, an increase in the mortgage loan to total
tn

loan ratio reveals that mortgage loan increases more compared to the increase of total loan of a bank. (2)

Size of mortgage loan (Log Mortgage Loan) (Dutkowsky and VanHoose, 2020; Albertazzi et al., 2024; Evans
rin

and Robertson, 2018; Fabiani et al., 2022): this figure represents the absolute size of mortgage loans

outstanding of a bank.

We take into consideration the Fed fund rate as our main independent variable (Dutkowsky and VanHoose,
ep

2020; Fabiani et al., 2022; Koch and Islam, 2024; Dinh, 2023). It affects the behavior of U.S. banks’ lending

activities even more prominently during the current situation of having no reserve requirement (Dinh, 2023).
Pr

Moreover, we consider a number of bank-specific control variables: the cost to income ratio (Cost/Income),

which shows the cost efficiency of bank; the net interest margin (NIM), representing the profitability of banks;

the cash to total assets ratio (Cash/TA), indicating banks holding of cash; the equity to total assets ratio

4
This preprint research paper has not been peer reviewed. Electronic copy available at: https://ssrn.com/abstract=4757302
 (Equity/TA) (Fabiani et al., 2022), showing the level of equity of banks; the loan to total assets ratio (Loan/TA),

representing how aggressive banks are in their lending operations; the debt to total assets ratio (Debt/TA),

ed
showing the level of bank leverage; the loan to deposit ratio (Loan/Deposit), referring to the percentage of

loan compared to deposit during no reserve requirement; the LogTA, which refers to bank size in natural log

iew
(Fabiani et al., 2022); the consumer loan to total loan ratio (Consumer Loan/TL), presenting the percentage

of consumer loan in total loan; the commercial loan to total loan ratio (Commercial Loan/TL), showing the

percentage of commercial loan in total loan; the Log Consumer Loan, representing the size of consumer

loan; and, finally, the Log Commercial Loan, presenting the size of commercial loan of bank.

ev
Furthermore, we include the following country-level explanatory variables: LogCovid-19 (Hansen et al.,

2024), representing the Covid-19 cases in the U.S. taken as natural logarithm; LogEPU, indicating the

r
economic policy uncertainty in the U.S. taken as natural logarithm; GDP growth rate (GDP) (Fabiani et al.,

2022, Albertazzi et al., 2024), representing economic growth; PCE inflation (Inflation) (Albertazzi et al., 2024;

er
Dutkowsky and VanHoose, 2020; Fabiani et al., 2022), presenting the value of money in the economy;

LogReserve, indicating the banks’ excess reserve with the Fed (Fabiani et al., 2022; Dutkowsky and
pe
VanHoose, 2020) during no reserve requirement; and LogHousePrice (Brueckner et al., 2012; Akçay et al.,

2023), referring to the median house sales price in the U.S. taken as natural logarithm.

The data of banks’ quarterly financial statements, excess reserve with the Fed, Fed funds rate, and GDP
ot

growth rate are collected from Refinitiv Workspace. Moreover, the YCharts database provides quarterly PCE

inflation rate data, EPU index database provides data of economic policy uncertainty in the U.S., and the
tn

FRED database makes available the data of median house sales price in the U.S.

2.2 Methodology and model development

rin

For testing hypothesis H1, we apply ordinary least squares (OLS) models and to test the validity of the models

we apply a difference generalized method of moments (GMM) approach.

ep

2.2.1 OLS estimator

Firstly, we run the following OLS regression models to find out the impact of Fed funds rate on mortgage
Pr

lending of U.S. banks.

(𝑀𝑜𝑟𝑡𝑔𝑎𝑔𝑒 𝐿𝑜𝑎𝑛/𝑇𝐿)𝑖,𝑡 = 𝛼 + 𝛽1(𝐹𝑒𝑑 𝑅𝑎𝑡𝑒)𝑡 + 𝛽𝑗 (𝐶𝑜𝑛𝑡𝑟𝑜𝑙)𝑖,𝑡 + 𝜀𝑖,𝑡 (𝑖)

5
This preprint research paper has not been peer reviewed. Electronic copy available at: https://ssrn.com/abstract=4757302
 (𝐿𝑜𝑔 𝑀𝑜𝑟𝑡𝑔𝑎𝑔𝑒 𝐿𝑜𝑎𝑛)𝑖,𝑡 = 𝛼 + 𝛽1(𝐹𝑒𝑑 𝑅𝑎𝑡𝑒)𝑡 + 𝛽𝑗 (𝐶𝑜𝑛𝑡𝑟𝑜𝑙)𝑖,𝑡 + 𝜀𝑖,𝑡 (𝑖𝑖)

ed
In these equations, (𝑀𝑜𝑟𝑡𝑔𝑎𝑔𝑒 𝐿𝑜𝑎𝑛/𝑇𝐿)𝑖,𝑡 is the percentage of mortgage loan in banks’ total loan.

(𝐿𝑜𝑔 𝑀𝑜𝑟𝑡𝑔𝑎𝑔𝑒 𝐿𝑜𝑎𝑛)𝑖,𝑡 represents the amount of mortgage loan taken as natural logarithm. 𝛼 refers to the

constant term. (𝐹𝑒𝑑 𝑅𝑎𝑡𝑒)𝑡 is the Fed funds rate (independent variable). (𝐶𝑜𝑛𝑡𝑟𝑜𝑙)𝑖,𝑡 consists of the bank-

iew
specific and country-level control variables, and 𝜀𝑖,𝑡 stands for error term. 𝛽1 and the vector 𝛽𝑗 indicate the

parameters to be estimated.

2.2.2 Two-step difference generalized method of moments (GMM) estimator

ev
Our study applies the following difference GMM equations as dynamic models which contain the value of a

lagged dependent variable to estimate the impact of Fed funds rate on mortgage lending of U.S. banks (Koch

r
and Islam, 2024; Heitmann et al., 2023).

er
(𝑀𝑜𝑟𝑡𝑔𝑎𝑔𝑒 𝐿𝑜𝑎𝑛/𝑇𝐿)𝑖,𝑡 = 𝛽1(𝑀𝑜𝑟𝑡𝑔𝑎𝑔𝑒 𝐿𝑜𝑎𝑛/𝑇𝐿)𝑖,𝑡―1 + 𝛽2(𝐹𝑒𝑑 𝑅𝑎𝑡𝑒)𝑡 + 𝛽3𝑋𝑖,𝑡 + 𝛽4𝑍𝑖,𝑡 + 𝑣𝑖 + 𝜀𝑖,𝑡

(𝐿𝑜𝑔 𝑀𝑜𝑟𝑡𝑔𝑎𝑔𝑒 𝐿𝑜𝑎𝑛)𝑖,𝑡 = 𝛽1(𝐿𝑜𝑔 𝑀𝑜𝑟𝑡𝑔𝑎𝑔𝑒 𝐿𝑜𝑎𝑛)𝑖,𝑡―1 + 𝛽2(𝐹𝑒𝑑 𝑅𝑎𝑡𝑒)𝑡 + 𝛽3𝑋𝑖,𝑡 + 𝛽4𝑍𝑖,𝑡 + 𝑣𝑖 + 𝜀𝑖,𝑡
(𝑖𝑖𝑖)

(𝑖𝑣)
pe
Here, (𝑀𝑜𝑟𝑡𝑔𝑎𝑔𝑒 𝐿𝑜𝑎𝑛/𝑇𝐿)𝑖,𝑡 refers to the dependent variable for bank 𝑖 in the year 𝑡.

(𝑀𝑜𝑟𝑡𝑔𝑎𝑔𝑒 𝐿𝑜𝑎𝑛/𝑇𝐿)𝑖,𝑡―1 denotes the dependent variable in the year 𝑡 ―1. (𝐿𝑜𝑔 𝑀𝑜𝑟𝑡𝑔𝑎𝑔𝑒 𝐿𝑜𝑎𝑛)𝑖,𝑡 is the

dependent variable for bank 𝑖 in the year 𝑡 and (𝐿𝑜𝑔 𝑀𝑜𝑟𝑡𝑔𝑎𝑔𝑒 𝐿𝑜𝑎𝑛)𝑖,𝑡―1 is the dependent variable in the
ot

year 𝑡 ―1. (𝐹𝑒𝑑 𝑅𝑎𝑡𝑒)𝑡 indicates our main independent variable, 𝑋𝑖,𝑡 refers to a vector of endogenous

variables, and 𝑍𝑖,𝑡 is a vector of explanatory variables. The bank-specific time-invariant effect is represented
tn

by 𝑣𝑖. 𝑣𝑖 serves as a year control effect, and 𝜀𝑖,𝑡 is an error term.

2.3 Descriptive statistics

rin

Table 1 presents the descriptive statistics of the sample of 40 U.S. banks. The table reveals the total number

of observations (N), mean, standard deviation, skewness, and kurtosis of the variables of our study.
ep
Pr

6
This preprint research paper has not been peer reviewed. Electronic copy available at: https://ssrn.com/abstract=4757302
 Table 1: Descriptive statistics
N Mean SD Skewness Kurtosis
Mortgage Loan/TL 435 48.017 22.885 0.194 1.963

ed
Log Mortgage Loan 431 9.458 1.156 1.124 4.201
Fed Rate 435 1.792 2.006 0.634 1.653
Cost/Income 417 55.056 15.871 -0.602 19.478
NIM 433 3.114 0.778 1.899 10.233
Cash/TA 435 2.548 4.318 3.570 16.500

iew
Equity/TA 433 11.024 2.751 0.744 3.351
Loan/TA 435 64.258 15.309 -1.817 7.897
Debt/TA 432 6.638 5.320 2.140 11.205
Loan/Deposit 435 0.811 0.144 0.371 6.036
LogTA 435 10.806 1.504 1.167 3.966
Consumer Loan/TL 435 14.121 16.536 1.997 6.864

ev
Commercial Loan/TL 435 33.552 16.980 0.355 2.473
Log Consumer Loan 426 7.524 2.759 -0.670 5.296
Log Commercial Loan 431 8.991 2.022 -1.476 9.629
LogCovid-19 435 15.684 0.852 -0.680 3.469
LogEPU 435 5.066 0.175 1.354 3.967

r
GDP 435 3.155 2.680 -0.146 2.110
Inflation 435 4.901 1.814 -0.217 2.035
LogReserve 435 8.166 0.114 0.350 1.470
LogHousePrice 435
er
12.961 0.073 -0.312 2.521

Table 2 presents the correlation matrix revealing all correlations among the independent variables. No
pe
correlation coefficient is close to 1 or -1, which reveals that no perfect multicollinearity exists among
independent variables.

3. Results and discussions

ot

3.1. OLS results

To test hypothesis H1, OLS estimations have been applied and the results are presented in Table 3. The
tn

results, after controlling for bank-level and country-level variables, reveal that a higher Fed funds rate

positively impacts both the mortgage loan to total loan ratio (Mortgage Loan/TL) and the absolute size of

mortgage loan (Log Mortgage Loan) of U.S. banks. This finding economically implies that a higher Fed funds
rin

rate cannot control mortgage lending of U.S. banks during high inflation, high house sales prices, and in

absence of reserve requirement. Therefore, it seems that the Fed funds rate is ineffective to control, i.e.,
ep

reduce, money supply through the largest lending channel, i.e., mortgage loans, of U.S. banks.
Pr

7
This preprint research paper has not been peer reviewed. Electronic copy available at: https://ssrn.com/abstract=4757302
 Pr
Table 2: Correlation matrix
ep
Variables Fed Rate Cash/TA Cost/ Equity/TA Loan/TA LogTA NIM Debt/TA LogCovid-19 LogEPU GDP LogReserve Inflation LogHouse Consumer Commercial Log Log
Income Price Loan/TL Loan/TL Consumer Commercial
Loan Loan

Fed Rate 1
Cash/TA -0.098 1
rin
Cost/Income -0.040 0.022 1
Equity/TA -0.123 -0.068 -0.066 1
Loan/TA 0.051 -0.286 -0.123 0.114 1
LogTA 0.045 -0.235 0.160 -0.252 -0.431 1
NIM 0.226 -0.113 -0.234 0.314 0.391 -0.156 1
Debt/TA 0.281 -0.114 0.178 -0.334 -0.218 0.487 -0.151 1
LogCovid-19 -0.652 0.040 0.023 0.028 -0.048 -0.004 -0.098 -0.218 1
tn
LogEPU -0.221 0.017 0.031 -0.015 0.019 0.002 -0.011 -0.013 0.503 1
GDP -0.300 0.066 0.005 0.097 0.017 -0.055 -0.062 -0.026 -0.183 -0.180 1
LogReserve -0.737 0.097 0.055 0.121 -0.059 -0.050 -0.223 -0.228 0.369 -0.115 0.307 1
Inflation -0.548 0.018 0.034 0.032 -0.086 0.002 -0.143 -0.259 0.454 -0.156 -0.231 0.572 1
LogHousePrice 0.287 -0.082 -0.004 -0.105 -0.049 0.055 0.082 -0.096 0.028 -0.029 -0.546 -0.179 0.429 1
Consumer -0.018 -0.195 0.101 -0.134 -0.027 0.511 0.257 0.234 0.009 0.005 0.015 0.011 -0.005 -0.031 1
Loan/TL
ot
Commercial -0.008 -0.176 -0.192 -0.218 -0.123 0.249 -0.120 0.037 0.004 0.007 0.001 -0.013 -0.003 -0.013 -0.067 1
Loan/TL

8
Log Consumer 0.020 -0.487 0.207 -0.150 -0.103 0.798 0.051 0.346 0.001 -0.012 -0.020 -0.034 0.006 0.020 0.687 0.204 1
Loan
Log 0.039 -0.299 0.072 -0.266 -0.309 0.894 -0.110 0.379 0.002 -0.006 -0.046 -0.074 -0.002 0.042 0.364 0.500 0.799 1
Commercial
Loan
pe
Loan/Deposit 0.133 -0.066 -0.231 0.030 0.797 -0.326 0.363 0.066 -0.113 0.005 0.030 -0.131 -0.176 -0.103 -0.004 -0.059 -0.187 -0.196
er
r ev
iew
ed

This preprint research paper has not been peer reviewed. Electronic copy available at: https://ssrn.com/abstract=4757302
 Table 3: Impact of Fed funds rate on mortgage loan of U.S. banks
Variables Mortgage Loan/TL Log Mortgage Loan

ed
Fed Rate 1.495** 0.053***
(0.677) (0.012)
Cost/Income 0.059* -
(0.036)
NIM -1.437* -0.123

iew
(0.859) (0.076)
Cash/TA 0.320** -0.016
(0.151) (0.017)
Equity/TA 0.243 0.017
(0.222) (0.024)
Loan/TA 0.021 0.006
(0.077) (0.005)

ev
Debt/TA -0.041 -0.025**
(0.140) (0.011)
Loan/Deposit 4.570 0.718
(7.403) (0.673)
LogTA -2.185*** 1.102***

r
(0.539) (0.154)
Consumer Loan/TL -0.776*** -0.135***
(0.041) (0.036)
Commercial Loan/TL

Log Consumer Loan -

er
-0.770***
(0.034)
-0.104
(0.117)
-0.135***
(0.036)
pe
Log Commercial Loan - -0.104
(0.117)
LogCovid-19 0.623 0.022
(1.004) (0.015)
LogEPU 2.125 0.026
(4.967) (0.046)
GDP 0.177 0.005*
ot

(0.282) (0.002)
Inflation 0.807 0.015*
(0.712) (0.007)
LogReserve 1.221 -0.330***
tn

(7.484) (0.099)
LogHousePrice 9.778 0.105
(12.864) (0.306)
Constant -63.324 -0.431
(176.151) (3.807)
Observations 410 419
rin

R-squared 0.815 0.907

Standard errors in parentheses. *** p<0.01, ** p<0.05, * p<0.1

3.2. Robustness analysis: difference generalized method of moments (GMM) results

ep

Furthermore, we apply a difference GMM estimator (Table 4), to eliminate potential concerns of endogeneity.

Lagged values of potentially endogenous variables are used in this method as their instrument variables.
Pr

Therefore, these lagged values in earlier quarters cannot influence mortgage lending in later quarters (Koch

and Islam, 2024; Heitmann et al., 2023). The robustness test results after transformation demonstrate that

endogeneity is unlikely in our OLS models.

9
This preprint research paper has not been peer reviewed. Electronic copy available at: https://ssrn.com/abstract=4757302
 Table 4: Robustness test: Different GMM effects of Fed funds rate on mortgage loan
Variables Mortgage Loan/TL Log Mortgage Loan

ed
Lagged Mortgage Loan/TL -0.074** -
(0.029)
Lagged Log Mortgage Loan - -0.066***
(0.014)
Fed Rate 1.129** 0.037***

iew
(0.439) (0.004)
Cost/Income -0.027 -
(0.022)
NIM -0.034 -0.000
(1.072) (0.015)
Cash/TA -0.077 -0.015**
(0.160) (0.007)

ev
Equity/TA 0.217 -0.039***
(0.533) (0.006)
Loan/TA -0.079 -0.026***
(0.338) 0.005)
Debt/TA -0.344 -0.022***

r
(0.311) (0.002)
Loan/Deposit 7.450 1.625***
(20.563) (0.217)
LogTA

Consumer Loan/TL
5.110
(4.220)
er
-1.285***
(0.219)
0.630***
(0.101)
-
pe
Commercial Loan/TL -0.150 -
(0.263)
Log Consumer Loan - -0.092**
(0.040)
Log Commercial Loan - -0.109**
(0.052)
LogCovid-19 0.118 0.002
ot

(0.367) (0.004)
LogEPU -2.870 0.075***
(1.937) (0.016)
GDP 0.037 0.001*
tn

(0.070) (0.001)
Inflation 0.452** 0.007***
(0.214) (0.001)
LogReserve 12.173** -0.281***
(5.128) (0.039)
LogHousePrice 1.891 0.187*
rin

(5.672) (0.110)

Observations 326 333

Instrument rank 40 40
ep

No. of groups 40 40
Arellano-Bond: AR(1) 0.663 0.421
Arellano-Bond: AR(2) 0.953 0.762
Sargan test (p-val) 0.594 0.119
Pr

Standard errors in brackets. * p<0.1, ** p<0.05, *** p<0.01

Post estimation specification tests, like instrument validity and autocorrelations, have been performed and

presented in Table 4 to test the consistency of the models in our study. The second-order autocorrelation’s

10
This preprint research paper has not been peer reviewed. Electronic copy available at: https://ssrn.com/abstract=4757302
 p-value reveals that the models in our study do not have autocorrelation problems according to Arellano and

Bond (1991) test. Finally, the Sargan test confirms the validity of the instruments because p-values in all

ed
models are not statistically significant.

Therefore, the results of GMM validate the results of OLS estimators and reveal that the Fed funds rate

iew
positively impacts mortgage lending of U.S. banks. In other words, the Fed funds rate positively impacts both

the mortgage loan to total loan ratio (Mortgage Loan/TL) and the size of mortgage loan (Log Mortgage Loan).

More precisely, the findings reveal that when the Fed funds rate increases, mortgage loan in total loan

portfolio increases and the size of total mortgage loan also increases. Therefore, we conclude that the Fed

ev
funds rate cannot control mortgage lending of U.S. banks during high inflation and high house sales prices

in absence of reserve requirements.

r
The results are surprising and contradict the expectations. However, the little power of the Fed to control

er
mortgage lending with the Fed funds rate might be explained by a big portion of fixed-rate mortgage and a

small portion of variable-rate mortgage in mortgage lending portfolio of the U.S. banks. Moreover, the
pe
mortgage market can behave differently at the time of high inflation, high house sales price, and no reserve

requirement for banks that can weaken the influence of Fed funds rate. Furthermore, it seems that in times

of high inflation and increasing house prices, people see a good alternative in buying houses instead of

investing money somewhere else – maybe, in hope of further increasing house prices.
ot

4. Conclusions and policy implications

tn

Our study empirically finds that the Fed funds rate positively impacts mortgage lending of banks during high

inflation and high house prices in the absence of reserve requirements for banks: mortgage lending activities

are not limited but even grow. This can be explained by individuals who seek alternative investments to
rin

protect wealth from inflation’s erosion – a behavior that increases the demand for houses even during higher

Fed fund rates. This is especially the case if individuals think that inflation might get even higher and housing

prices will still increase. Moreover, increasing prices might lead to further speculative behavior in the housing
ep

market. The effect of high Fed funds rates, however, cannot prevent banks from granting loans. Therefore,

the Fed funds rate cannot control money supply through reducing mortgage lending which is a matter of
Pr

concern since mortgage lending holds a major portion of banks’ lending portfolios. Moreover, it has been

evidenced that house sales prices in the U.S. are currently drastically declining after a massive boom which

can decrease the value of mortgage significantly in near future and the banks might come closer to a financial

11
This preprint research paper has not been peer reviewed. Electronic copy available at: https://ssrn.com/abstract=4757302
 crisis. Therefore, it is important for the policy makers to consider such possible effects. One possible solution

could be the reintroduction of reserve requirements for banks which influence loanable funds. Alternatively,

ed
it might be worthwhile to think about a new form of reserve requirement that is dependent on the portion of

mortgage loans in banks’ total loan portfolio to control banks’ mortgage lending activities – without effecting

iew
other lending activities, like consumer and commercial loans, because this supports the consumption and

production. Moreover, increasing the portion of variable-rate mortgage compared to fixed-rate mortgage in

the mortgage loan portfolio of banks could help banks to more effectively avoid discrepancies between

earning low incomes from low fixed rates and having to pay higher interests on deposit accounts when the

ev
Fed funds rate increases considerably. It also supports to control mortgage lending by reducing the demand

of variable-rate mortgage loans when borrowers expect even higher Fed funds rate in near future. Without

r
any reasonable action, a sudden decline in house sales prices can considerably increase the threat of a new

financial crisis and banks might collapse in near future.

References
er
pe
Akçay, S. B., Karul, C., & Akyuz, M. (2023). Mortgage Credit and House Prices: the Turkish
Case. International Journal of Housing Markets and Analysis, 16(2), 318–335.
https://doi.org/10.1108/IJHMA-11-2021-0127 .

Albertazzi, U., Fringuellotti, F., & Ongena, S. 2024. Fixed Rate Versus Adjustable Rate Mortgages:
ot

Evidence from Euro Area Banks. European Economic Review, 161, 104643.
https://doi.org/10.1016/j.euroecorev.2023.104643.
tn

Arellano, M., Bond, S., 1991. Some Tests of Specification for Panel Data: Monte Carlo Evidence and an
Application to Employment Equations. The Review of Economic Studies, 58(2), 277–297.
https://doi.org/10.2307/2297968.
rin

Brueckner, J. K., Calem, P. S., & Nakamura, L. I. (2012). Subprime Mortgages and the Housing
Bubble. Journal of Urban Economics, 71(2), 230–243. https://doi.org/10.1016/j.jue.2011.09.002.

Choi, J. W. (2013). The 2007–2010 US Financial Crisis: Its Origins, Progressions, and Solutions. The
ep

Journal of Economic Asymmetries, 10(2), 65–77. https://doi.org/10.1016/j.jeca.2013.11.003 .

Dinh, H.T., 2023. The Current Banking Crisis and US Monetary Policy (No. 1968). Policy Center for the
New South. https://www.policycenter.ma/sites/default/files/2023-05/PP_10-23_Hinh_T_Dinh.pdf.
Pr

Dutkowsky, D. H., & VanHoose, D. D. (2020). Equal Treatment under the Fed: Interest on Reserves, the
Federal Funds Rate, and the ‘Third Regime’ of Bank Behavior. Journal of Economics and Business, 107,
105860. https://doi.org/10.1016/j.jeconbus.2019.105860.

12
This preprint research paper has not been peer reviewed. Electronic copy available at: https://ssrn.com/abstract=4757302
 EPU, 2024, US EPU (Monthly, Daily, Categorical). https://www.policyuncertainty.com/us_monthly.html.
Accessed: 08 February 2024.

ed
Evans, J. D., & Robertson, M. L. (2018). The Effects of the Fed’s Monetary Tightening Campaign on
Nonbank Mortgage Lending. Economics Letters, 171, 164–168.
https://doi.org/10.1016/j.econlet.2018.07.017.

iew
Fabiani, A., Piñeros, M. L., Peydró, J. L., & Soto, P. E. (2022). Capital Controls, Domestic Macroprudential
Policy and the Bank Lending Channel of Monetary Policy. Journal of International Economics, 139, 103677.
https://doi.org/10.1016/j.jinteco.2022.103677.

FRED, 2024, Median Sales Price of Houses Sold for the United States (MSPUS).

ev
https://fred.stlouisfed.org/series/MSPUS. Accessed: 28 December 2023.

Hansen, J. H., Møller, S. V., Pedersen, T. Q., & Schütte, C. M. (2024). House Price Bubbles under the
Covid-19 Pandemic. Journal of Empirical Finance, 101462. https://doi.org/10.1016/j.jempfin.2023.101462.

r
Heitmann, D., Chowdhury, M.A.F., & Islam, M.S., 2023. Heterogeneous Impact of Covid-19 on the US

https://doi.org/10.1016/j.najef.2023.101990. er
Banking Sector. The North American Journal of Economics and Finance, 68, 101990.

Koch, J. A., & Islam, M. S. 2024. Impact of Higher Federal Funds Rates on Bank Risk during Higher
pe
Inflation in the US. Finance Research Letters, 60, 104866. https://doi.org/10.1016/j.frl.2023.104866.

Sachs Realty, 2024. Unstoppable Housing Market Crash with Peter Schiff. [Video]. January. YouTube.
https://youtu.be/ubHehecl40E.
ot

YCharts, 2024. US PCE Inflation Rate (I:USPCEQIR). US PCE Inflation Rate.

https://ycharts.com/indicators/us_pce_quarterly_inflation_rate#:~:text=US%20PCE%20Inflation%20Rate%
20is,in%20price%20over%20a%20year. Accessed: 26 January 2024.
tn
rin
ep
Pr

13
This preprint research paper has not been peer reviewed. Electronic copy available at: https://ssrn.com/abstract=4757302