Financing Competitors: Shadow Banks' Funding and Mortgage Market Competition.

This article investigates the funding relationship between shadow banks—nondepository mortgage lenders—and traditional banks that compete with them in the U.S. residential mortgage market. Using novel loan-level data, it finds that shadow banks obtain most of their warehouse line credit funding from competing banks, which possess upstream market power due to product differentiation and synergy between upstream funding and downstream mortgage origination. This market power enables banks to strategically raise shadow banks' funding costs and maintain higher mortgage rates, thereby softening competition and limiting shadow banks' ability to serve borrowers who value their services most, such as younger or lower-income households. A calibrated quantitative model quantifies these effects and shows that secondary market innovations, like faster loan sales, could reduce shadow banks' reliance on competitor banks' funding, enhancing downstream competition and consumer welfare.