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We study how the Federal Reserve's normalization plan influences interconnected mortgage credit markets that bridge the traditional and shadow banking sectors. Over key time periods (2006, 2009, 2015) in a time-varying factor-augmented vector autoregression with stochastic volatility, we document that increases in the shadow policy rate used to proxy the normalization plan lead to falls in bank mortgages partially offset by rises in nonbank mortgages. Monetary policy changes affect funding opportunities in securitized mortgage markets, lenders' willingness to lend, and economic conditions impacting mortgage demand that determine lenders' financial condition and numbers of mortgages extended. Banks, hampered by regulations, internalize a monetary policy contraction into fewer mortgages. Nonbanks take advantage and continue to meet mortgage demand through funding in agency securitized mortgages markets. Our findings suggest that the unintended increase in nonbank mortgages may threaten financial stability from more highly leveraged nonbanks becoming more vulnerable to adverse shocks. |
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