Payback
Borrower Misreporting and Loan Performance
Mark Garmaise
Journal of Finance, forthcoming
Abstract:
Borrower misreporting is associated with seriously adverse loan outcomes. Significantly more residential mortgage borrowers reported personal assets just above round number thresholds than just below. Borrowers who reported above-threshold assets were almost 25 percentage points more likely to become delinquent (mean delinquency was 20%). For applicants with unverified assets, the increase in delinquency was greater than 40 percentage points. Misreporting was most frequent in areas with low financial literacy or social capital. Incorporating behavioral cues such as threshold effects into a risk assessment model improves its ability to uncover delinquencies, though at a cost of mischaracterizing some safe loans.
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Safer Ratios, Riskier Portfolios: Banks' Response to Government Aid
Ran Duchin & Denis Sosyura
Journal of Financial Economics, forthcoming
Abstract:
Using novel data on bank applications to the Troubled Asset Relief Program (TARP), we study the effect of government assistance on bank risk taking. Bailed-out banks initiate riskier loans and shift assets toward riskier securities after government support. However, this shift in risk occurs mostly within the same asset class and, therefore, remains undetected by regulatory capital ratios, which indicate improved capitalization at bailed-out banks. Consequently, these banks appear safer according to regulatory ratios, but show an increase in volatility and default risk. These findings are robust to controlling for credit demand and account for selection of TARP recipients by exploiting banks' geography-based political connections as an instrument for bailout approvals.
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Wenli Li, Ishani Tewari & Michelle White
NBER Working Paper, March 2014
Abstract:
We assess the credit market impact of allowing mortgage "strip-down" - that is, reducing the principal of underwater residential mortgages to the current market value of the property for homeowners in Chapter 13 bankruptcy. Our identification is provided by a series of U.S. Circuit Court of Appeals decisions in the early 1990's that introduced mortgage strip-down in parts of the U.S., followed by a 1993 Supreme Court ruling that abolished it all over the U.S. We find that the Supreme Court decision led to a short-term reduction of 3% in mortgage interest rates and a short-term increase of 1% in mortgage approval rates, but only the approval rate effect persists in longer sample periods. In contrast, the circuit court decisions to allow strip-down did not have consistent effects on mortgage terms. We also show that strip-down had little effect on default rates by homeowners with existing mortgages. Taken together, these results suggest that mortgage lenders responded weakly to both the adoption and abolition of strip-down because strip-down had little effect on their profits from mortgage lending. According to these findings, re-introducing strip-down of mortgages in bankruptcy as a foreclosure-prevention program would have only small and transient effects on the supply of mortgage loans.
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Does Mortgage Deregulation Increase Foreclosures? Evidence from Cleveland
Yilan Xu
Regional Science and Urban Economics, forthcoming
Abstract:
This paper examines how relaxing a local anti-predatory lending law for mortgages affects foreclosures. The empirical evidence is drawn from a quasi experiment in Cleveland, Ohio, where the State Supreme Court repealed an ordinance that imposed lending restrictions on home mortgages of high Annual Percentage Rates (APRs). Empirical evidence shows that observable loan and borrower characteristics were not affected by the repeal, nor did the overall originations appear to increase; yet the APRs were 20 percent more likely to exceed the regulatory thresholds that were nullified. Moreover, the foreclosure rate increased by six percentage points to 20 percent.
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Heterogeneity and Stability: Bolster the Strong, Not the Weak
Dong Beom Choi
Review of Financial Studies, forthcoming
Abstract:
We first study a stylized model of self-fulfilling panic among agents with differing fragilities to strategic risk and show that depending on the severity of coordination problems, the panic trigger threshold can depend only on one type's fragility. We then present a model of systemic panic among financial institutions with heterogeneous fragilities to financial spillovers. Concerns about potential spillovers generate strategic interaction, triggering a pre-emption game in which one tries to exit the market before others to avoid spillovers. Although financial contagion originates in weaker institutions, systemic risk can critically depend on the financial health of stronger institutions in the contagion chain. In this case, bolstering the strong, rather than the weak, more effectively enhances systemic stability.
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Credit Card Blues: The Middle Class and the Hidden Costs of Easy Credit
Randy Hodson, Rachel Dwyer & Lisa Neilson
Sociological Quarterly, Spring 2014, Pages 315-340
Abstract:
In an era of increased access to credit, it becomes increasingly important to understand the consequences of taking on unsecured consumer debt. We argue that credit can have both positive and negative consequences resulting from its ability to smooth life transitions and difficulties but that this occurs simultaneously with increased financial risks and stress resulting from carrying unsecured debt. We find that those in the middle of the income distribution suffer the greatest disruptions to mental health from carrying debt. Affluent borrowers are relatively unmoved by debt, suggesting the use of short-term debt as a convenience strategy for the financially well heeled. The least advantaged borrowers also suffer emotionally less from debt, possibly because securing spendable funds for necessities remains their most pressing concern. The onset of the Great Recession, however, produced increased emotional distress for all classes.
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Inconsistent Regulators: Evidence from Banking
Sumit Agarwal et al.
Quarterly Journal of Economics, forthcoming
Abstract:
We find that regulators can implement identical rules inconsistently due to differences in their institutional design and incentives and that this behavior may adversely impact the effectiveness with which regulation is implemented. We study supervisory decisions of U.S. banking regulators and exploit a legally determined rotation policy that assigns federal and state supervisors to the same bank at exogenously set time intervals. Comparing federal and state regulator supervisory ratings within the same bank, we find that federal regulators are systematically tougher, downgrading supervisory ratings almost twice as frequently as state supervisors. State regulators counteract these downgrades to some degree by upgrading more frequently. Under federal regulators, banks report worse asset quality, higher regulatory capital ratios, and lower return on assets. Leniency of state regulators relative to their federal counterparts is related to costly outcomes, such as higher failure rates and lower repayment rates of government assistance funds. The discrepancy in regulator behavior is related to different weights given by regulators to local economic conditions and, to some extent, to differences in regulatory resources. We find no support for regulator self-interest, which includes "revolving doors" as a reason for leniency of state regulators.
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Corporate Taxes and Securitization
Joongho Han, Kwangwoo Park & George Pennacchi
Journal of Finance, forthcoming
Abstract:
Most banks pay corporate income taxes, but securitization vehicles do not. Our model shows that when a bank faces strong loan demand but limited deposit market power, this tax asymmetry creates an incentive to sell loans despite less-efficient screening and monitoring of sold loans. Moreover, loan-selling increases as a bank's corporate income tax rate and capital requirement rise. Our empirical tests show that U.S. commercial banks sell more of their mortgages when they operate in states that impose higher corporate income taxes. A policy implication is that tax-induced loan-selling will rise if banks' required equity capital increases.
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Do Big Banks Have Lower Operating Costs?
Anna Kovner, James Vickery & Lily Zhou
Economic Policy Review, forthcoming
Abstract:
This study examines the relationship between bank holding company (BHC) size and components of noninterest expense (NIE), in order to shed light on the sources of scale economies in banking. Drawing on detailed expense information provided by U.S. banking firms in the memoranda of their regulatory filings, the authors find a robust negative relationship between size and normalized measures of NIE. The relationship is strongest for employee compensation expenses and components of "other" noninterest expense such as information technology and corporate overhead expenses. In addition, the authors find no evidence that the inverse relationship between banking firm size and NIE ratios disappears above a given size threshold. In dollar terms, their estimates imply that for a BHC of mean size, an additional $1 billion in assets reduces noninterest expense by $1 million to $2 million per year, relative to a base case where operating cost ratios are unrelated to size.
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The Effects of Monetary Policy on Stock Market Bubbles: Some Evidence
Jordi Gali & Luca Gambetti
NBER Working Paper, March 2014
Abstract:
We estimate the response of stock prices to exogenous monetary policy shocks using a vector-autoregressive model with time-varying parameters. Our evidence points to protracted episodes in which, after a short-run decline, stock prices increase persistently in response to an exogenous tightening of monetary policy. That response is clearly at odds with the "conventional" view on the effects of monetary policy on bubbles, as well as with the predictions of bubbleless models. We also argue that it is unlikely that such evidence be accounted for by an endogenous response of the equity premium to the monetary policy shocks.
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Government Policies, Residential Mortgage Defaults and the Boom and Bust Cycle of Housing Prices
Marius Ascheberg et al.
Real Estate Economics, forthcoming
Abstract:
We develop a micro-based macromodel for residential home prices in an economy where defaults on residential mortgages negatively affect housing prices. Our model enables us to study the impact of subprime defaults on prime borrowers and the impact of various government policies on the housing market boom and bust cycle. In this regard, our key conclusions are that (i) there is a contagion effect from subprime defaults to prime defaults due to the negative impact of subprime defaults and (ii) monetary policy is the most effective tool for decreasing mortgage defaults and increasing aggregate home prices in contrast to alternative government fiscal policies designed to loosen mortgage credit.
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What Makes a Good Economy? Evidence from Public Opinion Surveys
Darren Grant
Economic Inquiry, forthcoming
Abstract:
Analysis of 35 years of previously unstudied survey data shows how the American public evaluates the health of the macroeconomy. Survey responses are multidimensional, distinct from indexes of "consumer sentiment," and based mostly on genuine perceptions of economic conditions, not media reports of economic statistics. As such, they contain unique information about current and future values of these statistics, particularly consumption growth, a longstanding focus of the literature. Both "intangibles" and macroeconomic fundamentals explain substantial variation in the survey data; the public equates 2 to 5 percentage points of inflation with 1 percentage point of unemployment.
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Components of U.S. Financial Sector Growth, 1950-2013
Samuel Antill, David Hou & Asani Sarkar
Economic Policy Review, forthcoming
Abstract:
We provide measures of the size of the financial sector and its components, estimated relative to that of the total business (financial and nonfinancial) sector, and show how they relate to firm type, firm size and valuation. We find that the financial sector has been growing consistently since 1959, until reversed by the recent financial crisis. The relative size of finance is smaller when private firm liabilities are excluded. Although financial firms are more prevalent among large firms, on average large and small financial firms grew at similar rates. Shadow banks have doubled in size since the 1970s, and have grown consistently relative to traditional banks until the recent financial crisis. Small shadow banks have grown faster than large shadow banks, while the reverse is true for traditional banks. Finally, we find that, as compared to nonfinancial firms, the stock market has valued (as indicated by the market-to-book ratio) financial firms in general and traditional banks in particular lower, but shadow banks higher, and that this "value gap" has grown over time. Overall, these results show that growth in finance has mainly occurred in opaque, complex and less-regulated subsectors of finance.
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Brent Ambrose & Moussa Diop
Journal of Urban Economics, May 2014, Pages 114-135
Abstract:
The dramatic expansion in subprime mortgage credit fueled a remarkable boom and bust in the US housing market and created a global financial crisis. Even though considerable research examines the housing and mortgage markets during the previous decade, how the expansion in mortgage credit affected the rental market remains unclear; and yet, over 30 percent of all U.S. households reside in the rental market. Our study fills this gap by showing how the multifamily rental market was adversely affected by the development of subprime lending in the single-family market before the advent of the 2007/2008 subprime induced financial crisis. We provide evidence for a fundamentals based linkage by which the effect of an innovation in one market (i.e, the growth in subprime mortgage originations) is propagated through to another market. Using a large database of residential rental lease payment records, our results confirm that the expansion in subprime lending corresponds with an overall decline in the quality of rental payments. Finally, we present evidence showing that the financial performance of multifamily rental properties reflected the increase in rental lease defaults.
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Iftekhar Hasan et al.
Journal of Financial Economics, forthcoming
Abstract:
We find that firms with greater tax avoidance incur higher spreads when obtaining bank loans. This finding is robust in a battery of sensitivity analyses and in two quasi-experimental settings including the implementation of Financial Accounting Standards Board Interpretation No. 48 and the revelation of past tax sheltering activity. Firms with greater tax avoidance also incur more stringent nonprice loan terms, incur higher at-issue bond spreads, and prefer bank loans over public bonds when obtaining debt financing. Overall, these findings indicate that banks perceive tax avoidance as engendering significant risks.
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Mortgage Brokers, Origination Fees, Price Transparency and Competition
Brent Ambrose & James Conklin
Real Estate Economics, forthcoming
Abstract:
This article examines the dynamics between mortgage broker competition, origination fees and price transparency. A reverse first-price sealed-bid auction model is used to motivate broker pricing behavior. Confirming the model predictions, our empirical analysis shows that increased mortgage brokerage competition at the Metropolitan Statistical Area level leads to lower fees. The findings are robust to different measures of fees as well as different measures of competition. We also provide evidence that broker competition reduces mortgage origination fees on retail (nonbrokered) loans as well. In addition, our results indicate that pricing complexity is an important determinant of fees, and increased broker competition is associated with a higher probability of a loan being priced with transparency. Our results suggest that mortgage brokers increase competition and lower fees in the mortgage market.
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Household Leveraging and Deleveraging
Alejandro Justiniano, Giorgio Primiceri & Andrea Tambalotti
Federal Reserve Working Paper, March 2013
Abstract:
U.S. households' debt skyrocketed between 2000 and 2007, but has since been falling. This leveraging and deleveraging cycle cannot be accounted for by the liberalization and subsequent tightening of mortgage credit standards that occurred during the period. We base this conclusion on a quantitative dynamic general equilibrium model calibrated using macroeconomic aggregates and microeconomic data from the Survey of Consumer Finances. From the perspective of the model, the credit cycle is more likely due to factors that impacted house prices more directly, thus affecting the availability of credit through a collateral channel. In either case, the macroeconomic consequences of leveraging and deleveraging are relatively minor because the responses of borrowers and lenders roughly wash out in the aggregate.
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Incentivizing Calculated Risk-Taking: Evidence from an Experiment with Commercial Bank Loan Officers
Shawn Allen Cole, Martin Kanz & Leora Klapper
Journal of Finance, forthcoming
Abstract:
We conduct an experiment with commercial bank loan officers to test how performance compensation affects risk-assessment and lending. High-powered incentives lead to greater screening effort and more profitable lending decisions. This effect is, however, muted by deferred compensation and limited liability, two standard features of loan officer compensation contracts. We find that career concerns and personality traits affect loan officer behavior, but show that the response to incentives does not vary with traits such as risk-aversion, optimism or overconfidence. Finally, we present evidence that incentive contracts distort the assessment of credit risk, even among trained professionals with many years of experience.
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Liquidity Trap and Excessive Leverage
Anton Korinek & Alp Simsek
NBER Working Paper, March 2014
Abstract:
We investigate the role of macroprudential policies in mitigating liquidity traps driven by deleveraging, using a simple Keynesian model. When constrained agents engage in deleveraging, the interest rate needs to fall to induce unconstrained agents to pick up the decline in aggregate demand. However, if the fall in the interest rate is limited by the zero lower bound, aggregate demand is insufficient and the economy enters a liquidity trap. In such an environment, agents' ex-ante leverage and insurance decisions are associated with aggregate demand externalities. The competitive equilibrium allocation is constrained inefficient. Welfare can be improved by ex-ante macroprudential policies such as debt limits and mandatory insurance requirements. The size of the required intervention depends on the differences in marginal propensity to consume between borrowers and lenders during the deleveraging episode. In our model, contractionary monetary policy is inferior to macroprudential policy in addressing excessive leverage, and it can even have the unintended consequence of increasing leverage.
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CDS as Insurance: Leaky Lifeboats in Stormy Seas
Eric Stephens & James Thompson
Journal of Financial Intermediation, forthcoming
Abstract:
What market features of financial risk transfer exacerbate counterparty risk? To analyze this, we formulate a model which elucidates important differences between financial risk transfer and traditional insurance, using the example of Credit Default Swaps (CDS). We allow for (heterogeneous) insurer insolvency, which captures the possibility that relatively risky counterparties may exist in the market. Further, we find that stable insurers become less stable as the price of the contract decreases. The analysis includes insured parties that have heterogeneous motivations for purchasing CDS. For example, some may own the underlying asset and purchase CDS for risk management, while others buy these contracts purely for trading purposes. We show that traders will choose to contract with less stable insurers, resulting in higher counterparty risk in this market relative to that of traditional insurance; however, a regulatory policy that removes traders can, perversely, cause stable counterparties to become less stable. We conclude with two extensions of the model that consider a Central Counterparty (CCP) arrangement and the consequences of asymmetric information over insurer type.