At this rate

Kevin Lewis

October 18, 2017

Seeing Like the Fed: Culture, Cognition, and Framing in the Failure to Anticipate the Financial Crisis of 2008
Neil Fligstein, Jonah Stuart Brundage & Michael Schultz
American Sociological Review, October 2017, Pages 879-909


One of the puzzles about the financial crisis of 2008 is why regulators, particularly the Federal Open Market Committee (FOMC), were so slow to recognize the impending collapse of the financial system and its broader consequences for the economy. We use theory from the literature on culture, cognition, and framing to explain this puzzle. Consistent with recent work on "positive asymmetry," we show how the FOMC generally interpreted discomforting facts in a positive light, marginalizing and normalizing anomalous information. We argue that all frames limit what can be understood, but the content of frames matters for how facts are identified and explained. We provide evidence that the Federal Reserve's primary frame for making sense of the economy was macroeconomic theory. The content of macroeconomics made it difficult for the FOMC to connect events into a narrative reflecting the links between foreclosures in the housing market, the financial instruments used to package the mortgages into securities, and the threats to the larger economy. We conclude with implications for the sociological literatures on framing and cognition and for decision-making in future crises.

Illuminating a Dark Side of the American Dream: Assessing the Prevalence and Predictors of Mortgage Fraud across U.S. Counties
Eric Baumer et al.
American Journal of Sociology, September 2017, Pages 549-603


Using novel county-level data, the authors document that nearly 25% of residential mortgage loans originated between 2003 and 2005 in America contained one or more indications of mortgage fraud but also that rates were highly variable across counties. Multivariate regression models reveal that rates of mortgage fraud were higher in areas with greater loan volumes, a larger share of loans originated by independent mortgage companies, elevated rates of preexisting property crime, and higher levels of black-white racial segregation; it was less prevalent where government-sponsored enterprises purchased a larger share of the loans sold in secondary mortgage markets. The findings are most consistent with classic and contemporary anomie theories and perspectives that highlight the geographic targeting of selected housing markets with loan products and tactics that provided fertile ground for mortgage fraud. The authors discuss the implications of these patterns for developing a more comprehensive understanding of contemporary spatial inequalities.

How Optimal is US Monetary Policy?
Xiaoshan Chen, Tatiana Kirsanova & Campbell Leith
Journal of Monetary Economics, forthcoming


Using a small-scale microfounded DSGE model with Markov switching in shock variances and policy parameters, we show that the data-preferred description of US monetary policy is a time-consistent targeting rule with a marked increase in conservatism after the 1970s. However, the Fed lost its conservatism temporarily in the aftermath of the 1987 stock market crash, and again following the 2000 dot-com crash and has not subsequently regained it. The high inflation of the 1970s would have been avoided had the Fed been able to commit, even without the appointment of Paul Volcker or the reduction in shock volatilities.

Inconsistent voting behaviour in the FOMC
Tom Lähner
Applied Economics, forthcoming


This article uses transcript data to examine determinants of inconsistent voting behaviour in the Federal Open Market Committee (FOMC) in the period 1989-2008. Inconsistent voting behaviour occurs if a member shows disagreement on the interest rate proposed by the chairman in the policy go-around, but this member agrees in the formal vote. Results show that after the 1993's increase in central bank transparency, the probability of casting inconsistent votes decreases significantly, on average by 3.3 percentage points. FOMC members with longer tenure on the committee have a lower probability of casting inconsistent votes. Further results suggest that board members and bank presidents differ significantly, with bank presidents casting inconsistent votes more often than board members do. This relation holds true for gender as well, with female members casting more inconsistent votes than males. In addition, political aspects and career backgrounds also contribute to explaining inconsistent voting behaviour in the FOMC. Conditional effects reveal that after the change in transparency, differences between board members and bank presidents remain, whereas differences between male and female members have diminished. What is more, FOMC members with a career in the government sector have been strongly affected by the regime shift in transparency.

The Politics of Central Bank Appointments
Caitlin Ainsley
Journal of Politics, October 2017, Pages 1205-1219


Monetary delegation to independent central banks is the institutional standard for responsible monetary policy making. Governments overcome their own high inflation biases by delegating policy-making discretion to conservative central bankers with political independence and long terms of appointment. With a formal model of central bank appointments and monetary policy making, I provide results suggesting this canonical result hinges on widespread, empirically false assumptions about the nature of central bank preferences and the economic environment in which monetary policy making occurs. During periods of heightened monetary uncertainty, delegation to an independent central bank is a less effective institutional solution to achieving inflation goals than extant theory suggests. Under realistic economic conditions, monetary delegation can result in economic outcomes even worse than those we would expect if the government had maintained discretion. I test several predictions from the model drawing appointments and monetary policy voting records from central banks in Hungary and the United Kingdom.

Measuring banks' market power in the presence of economies of scale: A scale-corrected Lerner index
Laura Spierdijka & Michalis Zaourasa
Journal of Banking & Finance, forthcoming


A positive Lerner index indicates a welfare loss for consumers due to deviations from marginal-cost pricing. Such a welfare loss may not always be due to market power, though. In particular, marginal-cost pricing would result in negative profit for the firm in the presence of economies of scale. In such a scenario, a positive Lerner index could simply reflect the firm's need to earn non-negative profits rather than market power. We propose a novel, scale-corrected price-cost margin for firms that produce in the economies of scale range. We show that this measure is more informative about market power than the Lerner index itself. As an empirical illustration, we analyze market power in the U.S. banking sector using both the corrected and uncorrected Lerner index. The corrected Lerner index reveals significant market power for U.S. commercial banks during the 2000 - 2014 period.

Readability of the credit card agreements and financial charges
Alyxandra Cash & Hui-Ju Tsai
Finance Research Letters, forthcoming


We examined the readability of credit card agreements and its relationship with financial charges. Examining the credit card agreements filed with the Consumer Financial Protection Bureau in 2014, we found that the typical credit card agreement is written at an 8th to 9th grade level, which is higher than the average American reading level. We show that the readability of credit card agreements is negatively related to financial charges: cards with easier-to-read agreements are associated with lower annual percentage rates, lower minimum monthly payments, and lower cash advance fees.

Did QE Lead Banks to Relax Their Lending Standards? Evidence from the Federal Reserve's LSAPs
Robert Kurtzman, Stephan Luck & Tom Zimmermann
Federal Reserve Working Paper, September 2017


Using confidential loan officer survey data on lending standards and internal risk ratings on loans, we document an effect of large-scale asset purchase programs (LSAPs) on lending standards and risk-taking. We exploit cross-sectional variation in banks' holdings of mortgage-backed securities to show that the first and third round of quantitative easing (QE1 and QE3) significantly lowered lending standards and increased loan risk characteristics. The magnitude of the effects is about the same in QE1 and QE3, and is comparable to the effect of a one percentage point decrease in the Fed funds target rate.

Does regulatory regime matter for bank risk taking? A comparative analysis of US and Canada
Sana Mohsni & Isaac Otchere
Journal of International Financial Markets, Institutions and Money, forthcoming


In the wake of the worst financial crisis in 2008, most US banks were bailed out while Canadian banks sailed through the crisis relatively unscathed. This has compelled some analysts to question why banking crises happen in America but not in Canada. We examine the risk-taking behavior of banks in the US and Canada prior to the recent financial crisis and find that Canadian banks had lower risk than their US counterparts over the study period. Further analysis shows that entry restrictions, which create concentrated banking structure, strong supervisory power, and discipline constrain excessive risk taking by Canadian banks. Entry restrictions enable Canadian banks to generate higher profits and lower variability of asset returns, while restrictions on activities reduce profitability and increase variability in asset return. However, the former seems to overwhelm the effect of asset restrictions, given the lower risk that we observe for the Canadian banks. The less concentrated but competitive banking structure in the US is associated with higher bank risk taking.

The Decline of Big-Bank Lending to Small Business: Dynamic Impacts on Local Credit and Labor Markets
Brian Chen, Samuel Hanson & Jeremy Stein
NBER Working Paper, September 2017


Small business lending by the four largest banks fell sharply relative to others in 2008 and remained depressed through 2014. We explore the dynamic adjustment process following this credit supply shock. In counties where the largest banks had a high market share, the aggregate flow of small business credit fell, interest rates rose, fewer businesses expanded, unemployment rose, and wages fell from 2006 to 2010. While the flow of credit recovered after 2010 as other lenders slowly filled the void, interest rates remain elevated. Although unemployment returns to normal by 2014, the effect on wages persists in these areas.

Credit and the Labor Share: Evidence from U.S. States
Asli Leblebicioğlu & Ariel Weinberger
University of Texas Working Paper, August 2017


We analyze the role of credit markets in explaining the changes in the U.S. labor share by evaluating the effects of state-level banking deregulation, which resulted in improved access to cheaper credit. Utilizing a difference-in-differences strategy, we provide causal evidence showing labor share declined following the interstate banking deregulation. We show that the lower cost of credit, increase in the availability of credit, and greater bank competition in each state are mechanisms that led to the decline in the labor share. We use this evidence to obtain the elasticity of labor share with respect to borrowing costs, which itself is informative about the aggregate elasticity of substitution between capital and labor. Finally, we focus on manufacturing and services to show that the impact of banking deregulation is particularly important in capital intensive and external finance dependent industries.

Financial exclusion in the USA: Looking beyond demographics
Nikolaos Mylonidis, Michael Chletsos & Vanessa Barbagianni
Journal of Financial Stability, forthcoming


We investigate the linkages between cultural factors and financial exclusion using detailed data from the 2013 wave of the Panel Study of Income Dynamics (PSID). Controlling for a large number of demographic characteristics and background factors, we find that Catholics are more likely to be excluded from basic banking services. In contrast, Jewish and religiously unaffiliated individuals are more likely to participate in retirement plans and the stock market. More importantly, we obtain economically important effects of social participation on financial exclusion. In particular, we document that individuals exhibiting a pro-social religious behavior, proxied by charitable giving, are less likely to be financially excluded. This effect remains robust to the use of earlier waves of the PSID, as well as to alternative estimation techniques which account for endogeneity of charitable giving and unobserved households' heterogeneity. Our findings highlight the need for the development of initiatives which promote social participation as a means of combating financial exclusion.

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