Journal of Real Estate Finance and Economics, 18:1, 125±139 (1999)
# 1999 Kluwer Academic Publishers, Boston. Manufactured in The Netherlands.
Residential Construction and Credit Market
THOMAS SAI-FAN CHAN
Nevada Public Utilities Commission, 1150 E. Williams St., Carson City, NV 89701
Using the asset market equilibrium approach, the effects of Financial Regulations, Reform, Recovery, and
Enforcement Act (1989), of the new housing selling time, and of the commercial paper±Treasury Bill spread,
through the credit markets, on total and speculative single-family housing construction are investigated. A new
speculative single-family housing starts series is developed for this analysis. The credit-market factors appear to
affect both the cost of construction loans and the price elasticity of single-family housing construction. These
effects are especially strong on speculative housing construction.
Key Words: residential construction, speculative housing construction, liquidity constraints
Recent research has established ample evidence that incomplete information in the credit
market may have signi®cant effects on ®rms' investment and production decisions; and
these effects are particularly severe on small ®rms (see, for example, Carpenter, Fazzari,
and Petersen, 1994; Gertler and Gilchrist, 1994). Residential housing builders are mostly
small ®rms with limited sources of external ®nance (Gertler and Hubbard, 1988).
effects of credit markets on housing supply, however, have received scarce attention in the
literature. This article explores this issue. It demonstrates that credit factors can affect both
the cost of construction loans and builders' ability to respond to price signals. These
effects appear to be particularly pronounced on speculative construction.
2. The Implications of Credit Market Imperfections on Residential Construction
Stiglitz and Weiss (1981) suggest that, when market information is incomplete, higher
interest rates may induce borrowers to invest in more risky projects (moral hazard) or
attract more risky borrowers (adverse selection).
Lenders may therefore prefer
noninterest-rate over interest-rate rationing. Brunner and Meltzer (1988) further argue
that banks assess default risk by borrower types and charge risk premiums accordingly. If a
rise in the price of loans (interest rates and registration fees) increases the default risk for
certain types of borrowers because of adverse selection or moral hazard, banks will have to
assess higher risk premiums on these borrowers through higher loan prices. Consequently,