Big banking
The Social Costs and Benefits of Too-Big-To-Fail Banks: A “Bounding” Exercise
John Boyd & Amanda Heitz
Journal of Banking & Finance, forthcoming
Abstract:
While the policy of Too-Big-To-Fail has received wide attention in the literature, there is little agreement regarding economies of scale for financial firms. We take the stand that systemic risk increases when the larger players in the financial sector have a larger share of output. Calculations indicate that the cost to the macro-economy due to increased systemic risk is always much larger than the potential benefit due to scale economies. When distributional and intergenerational issues are considered, the potential benefits to economies of scale are unlikely to ever exceed the potential costs due to increased risk of a banking crisis.
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Did TARP Banks Get Competitive Advantages?
Allen Berger & Raluca Roman
Journal of Financial and Quantitative Analysis, December 2015, Pages 1199-1236
Abstract:
We investigate whether the Troubled Assets Relief Program (TARP) gave recipients competitive advantages. Using a difference-in-difference (DID) approach, we find that: i) TARP recipients received competitive advantages and increased both their market shares and market power; ii) results may be driven primarily by the safety channel (TARP banks may be perceived as safer), which is partially offset by the cost-disadvantage channel (TARP funds may be relatively expensive); and iii) these competitive advantages are primarily or entirely due to TARP banks that repaid early. These results may help explain other findings in the literature, and yield important policy implications.
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Too-Big-To-Fail Before the Fed
Gary Gorton & Ellis Tallman
NBER Working Paper, March 2016
Abstract:
“Too-big-to-fail” is consistent with policies followed by private bank clearing houses during financial crises in the U.S. National Banking Era prior to the existence of the Federal Reserve System. Private bank clearing houses provided emergency lending to member banks during financial crises. This behavior strongly suggests that “too-big-to-fail” is not the problem causing modern crises. Rather it is a reasonable response to the threat posed to large banks by the vulnerability of short-term debt to runs.
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Financial Sector Reform after the Subprime Crisis: Has Anything Happened?
Alexander Schäfer, Isabel Schnabel & Beatrice Weder di Mauro
Review of Finance, March 2016, Pages 77-125
Abstract:
We analyze the reactions of stock returns and the spreads of credit default swaps (CDS) of banks from Europe and the USA to four major regulatory reforms in the aftermath of the subprime crisis, employing an event study analysis. Contrary to public perception, we find that financial markets indeed reacted to the structural reforms enacted at the national level. The reforms succeeded in reducing bail-out expectations relative to the post-bail-out period, especially for systemic banks. The strongest effects were found for the Dodd–Frank Act and in particular for the Volcker rule. Bank profitability was affected in all countries, showing up in lower equity returns.
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Did Dubious Mortgage Origination Practices Distort House Prices?
John Griffin & Gonzalo Maturana
Review of Financial Studies, forthcoming
Abstract:
ZIP codes with high concentrations of originators who misreported mortgage information experienced a 75% larger relative increase in house prices from 2003 to 2006 and a 90% larger relative decrease from 2007 to 2012 compared with other ZIP codes. Several causality tests show that high fractions of dubious originators in a ZIP code lead to large price distortions. Originators with high misreporting gave credit to borrowers with high ex ante risk, yet further understated the borrowers' true risk. Overall, excess credit facilitated through dubious origination practices explain much of the regional variation in house prices over a decade.
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Speculative Fever: Investor Contagion in the Housing Bubble
Patrick Bayer, Kyle Mangum & James Roberts
NBER Working Paper, March 2016
Abstract:
Historical anecdotes of new investors being drawn into a booming asset market, only to suffer when the market turns, abound. While the role of investor contagion in asset bubbles has been explored extensively in the theoretical literature, causal empirical evidence on the topic is virtually non-existent. This paper studies the recent boom and bust in the U.S. housing market, establishing that many novice investors entered the market as a direct result of observing investing activity of multiple forms in their own neighborhoods and that these “infected” investors performed poorly relative to other investors along several dimensions.
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Distributional Implications of Government Guarantees in Mortgage Markets
Pedro Gete & Franco Zecchetto
Georgetown University Working Paper, March 2016
Abstract:
We analyze the removal of the government guarantees from the mortgage market. We use a quantitative model in which mortgage spreads are endogenously related to borrowers' income. The guarantees generate credit subsidies that are heterogeneous across households. The removal of the guarantees leads to higher wealth inequality driven by uneven rises in mortgage spreads and housing costs. Leverage and housing affordability decrease for low and mid-income households while they increase for high-income households. Renters and high leveraged mortgagors with conforming loans, which are low and mid-income households, lose the most welfare from the removal of the guarantees.
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Credit Market Freedom and Cost Efficiency in US state banking
Georgios Chortareas, George Kapetanios & Alexia Ventouri
Journal of Empirical Finance, forthcoming
Abstract:
This paper investigates the dynamics between the credit market freedom counterparts of the economic freedom index drawn from the Fraser institute database and bank cost efficiency levels across the U.S. states. We consider a sample of 3,809 commercial banks per year, on average, over the period 1987-2012. After estimating cost efficiency scores using the Data Envelopment Analysis (DEA), we develop a fractional regression model to test the implications of financial freedom for bank efficiency. Our results indicate that banks operating in states that enjoy a higher degree of economic freedom are more cost efficient. Greater independence in financial and banking markets from government controls can result in higher bank efficiency. This effect emerges in addition to the efficiency enhancing effects of interstate banking and intrastate branching deregulation.
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Yu Gao, Scott Liao & Xue Wang
Journal of Banking & Finance, forthcoming
Abstract:
We examine stock and bond market reactions to the key events leading to the passage of the Dodd-Frank Act to assess the markets’ expectations about the effectiveness of the Act on systemically important financial firms. Using small/medium sized domestic financial institutions as a control group, we find that large financial institutions overall had negative abnormal stock returns and positive abnormal bond returns, suggesting that the markets expect the Act to be effective in reducing these banks’ risk-taking. We further investigate the market reactions for (1) larger and more interconnected financial institutions; and (2) the Big 6 banks to evaluate the markets’ assessment about the effectiveness of the act in ending the too-big-to-fail policy. We document that larger and more interconnected financial institutions experienced more negative abnormal stock returns and more positive abnormal bond returns as compared to other banks in our sample, but these relations are not present during the final phase of the passage. Likewise, we find that both shareholders and bondholders of the Big 6 banks initially experienced significant negative returns, followed by insignificant returns during the final phase of the passage. These results appear to suggest the markets are doubtful about the effectiveness of the final version of the bill to end the too-big-to-fail status in particular for the Big 6 banks.
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Lending on hold: Regulatory uncertainty and bank lending standards
Stefan Gissler, Jeremy Oldfather & Doriana Ruffino
Journal of Monetary Economics, forthcoming
Abstract:
The 2011—2013 rule-making process for the regulation of qualified mortgages was correlated with a reduction in mortgage lending. In this article, we document this correlation at the bank level. Using a novel measure of banks' perception of regulatory uncertainty, we offer suggestive evidence that banks that perceived higher regulatory uncertainty (or that were more adverse to it) reduced lending more severely. Other channels that might explain banks' lending behavior – investment/securitization, putbacks by government sponsored enterprises, and general economic uncertainty – are also considered.
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Michael Bordo, John Duca & Christoffer Koch
NBER Working Paper, February 2016
Abstract:
Economic policy uncertainty affects decisions of households, businesses, policy makers and Financial intermediaries. We first examine the impact of economic policy uncertainty on aggregate bank credit growth. Then we analyze commercial bank entity level data to gauge the effects of policy uncertainty on Financial intermediaries' lending. We exploit the cross-sectional heterogeneity to back out indirect evidence of its effects on businesses and households. We ask (i) whether, conditional on standard macroeconomic controls, economic policy uncertainty affected bank level credit growth, and (ii) whether there is variation in the impact related to banks' balance sheet conditions; that is, whether the effects are attributable to loan demand or, if impact varies with bank level financial constraints, loan supply. We find that policy uncertainty has a significant negative effect on bank credit growth. Since this impact varies meaningfully with some bank characteristics – particularly the overall capital-to-assets ratio and bank asset liquidity–loan supply factors at least partially (and significantly) help determine the influence of policy uncertainty. Because other studies have found important macroeconomic effects of bank lending growth on the macroeconomy, our findings are consistent with the possibility that high economic policy uncertainty may have slowed the U.S. economic recovery from the Great Recession by restraining overall credit growth through the bank lending channel.
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Macroeconomic Effects of Bankruptcy and Foreclosure Policies
Kurt Mitman
American Economic Review, forthcoming
Abstract:
I study the implications of two major debt-relief policies in the US: the Bankruptcy Abuse and Consumer Protection Act (BAPCPA) and the Home Affordable Refinance Program (HARP). To do so, I develop a model of housing and default that includes relevant dimensions of credit-market policy and captures rich heterogeneity in household balance sheets. The model also explains the observed cross-state variation in consumer default rates. I find that BAPCPA significantly reduced bankruptcy rates, but increased foreclosure rates when house prices fell. HARP reduced foreclosures by one percentage point and provided substantial welfare gains to households with high loan-to-value mortgages.
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Bank Competition and Financial Stability: Evidence from the Financial Crisis
Brian Akins et al.
Journal of Financial and Quantitative Analysis, February 2016, Pages 1-28
Abstract:
We examine the link between bank competition and financial stability using the recent financial crisis as the setting. We utilize variation in banking competition at the state level and find that banks facing less competition are more likely to engage in risky activities, more likely to face regulatory intervention, and more likely to fail. Focusing on the real estate market, we find that states with less competition had higher rates of mortgage approval, experienced greater inflation in housing prices before the crisis, and experienced a steeper decline in housing prices during the crisis. Overall, our study is consistent with greater competition increasing financial stability.
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Bank Competition: Measurement, Decision-Making and Risk-Taking
Robert Bushman, Bradley Hendricks & Christopher Williams
Journal of Accounting Research, forthcoming
Abstract:
This paper investigates whether greater competition increases or decreases individual bank and banking system risk. Using a new text-based measure of competition, and an instrumental variables analysis that exploits exogenous variation in bank deregulation, we provide robust evidence that greater competition increases both individual bank risk and a bank's contribution to system-wide risk. Specifically, we find that higher competition is associated with lower underwriting standards, less timely loan loss recognition, and a shift towards non-interest revenue. Further, we find that higher competition is associated with higher stand-alone risk of individual banks, greater sensitivity of a bank's downside equity risk to system-wide distress, and a greater contribution by individual banks to downside risk of the banking sector.
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Elimination of systemic risk in financial networks by means of a systemic risk transaction tax
Sebastian Poledna & Stefan Thurner
Quantitative Finance, forthcoming
Abstract:
Financial markets are exposed to systemic risk (SR), the risk that a major fraction of the system ceases to function, and collapses. It has recently become possible to quantify SR in terms of underlying financial networks where nodes represent financial institutions, and links capture the size and maturity of assets (loans), liabilities and other obligations, such as derivatives. We demonstrate that it is possible to quantify the share of SR that individual liabilities within a financial network contribute to the overall SR. We use empirical data of nationwide interbank liabilities to show that the marginal contribution to overall SR of liabilities for a given size varies by a factor of a thousand. We propose a tax on individual transactions that is proportional to their marginal contribution to overall SR. If a transaction does not increase SR, it is tax-free. With an agent-based model (ABM) (CRISIS macro-financial model), we demonstrate that the proposed ‘Systemic Risk Tax’ (SRT) leads to a self-organized restructuring of financial networks that are practically free of SR. The SRT can be seen as an insurance for the public against costs arising from cascading failure. ABM predictions are shown to be in remarkable agreement with the empirical data and can be used to understand the relation of credit risk and SR.
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Why Does Fast Loan Growth Predict Poor Performance for Banks?
Rüdiger Fahlenbrach, Robert Prilmeier & René Stulz
NBER Working Paper, March 2016
Abstract:
From 1973 to 2014, the common stock of U.S. banks with loan growth in the top quartile of banks over a three-year period significantly underperforms the common stock of banks with loan growth in the bottom quartile over the next three years. The benchmark-adjusted cumulative difference in performance over three years exceeds twelve percentage points. The high growth banks also have significantly higher crash risk over the three-year period. This poor performance is explained by fast loan growth as asset growth separate from loan growth is not followed by poor performance. These banks reserve less for loan losses when their loans grow quickly than other banks. Subsequently, they have a lower return on assets and increase their loan loss reserves. The poorer performance of the fast growing banks is not explained by merger activity and loan growth through mergers is not accompanied by the same poor loan performance. The evidence is consistent with fast-growing banks, analysts, and investors failing to properly appreciate the extent to which the fast loan growth results from making riskier loans and failing to charge for these risks correctly.
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How Did Pre-Fed Banking Panics End?
Gary Gorton & Ellis Tallman
NBER Working Paper, February 2016
Abstract:
How did pre-Fed banking crises end? How did depositors’ beliefs change? During the National Banking Era, 1863-1914, banks responded to the severe panics by suspending convertibility, that is, they refused to exchange cash for their liabilities (checking accounts). At the start of the suspension period, the private clearing houses cut off bank-specific information. Member banks were legally united into a single entity by the issuance of emergency loan certificates, a joint liability. A new market for certified checks opened, pricing the risk of clearing house failure. Certified checks traded at a discount to cash (a currency premium) in a market that opened during the suspension period. Confidence was restored when the currency premium reached zero.
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Property tax delinquency and its spillover effects on nearby properties
James Alm et al.
Regional Science and Urban Economics, May 2016, Pages 71–77
Abstract:
This paper investigates the impact of property tax delinquency on the sales price of nearby residential properties, an effect that we call the “delinquency discount”. We use a sample of 34,500 home sales and the population of delinquent properties for Chicago, Illinois during the period 2010 to 2013. We focus on the delinquency discount for properties within the same census block. We also examine the effect of delinquency duration on neighboring properties, as this measures the level of their financial distress. We estimate the magnitude of the delinquency discount using several alternative estimation methods, in each case controlling for local foreclosure activity. Our preferred method is a matching estimator, as it works to eliminate the potential for omitted variable bias that is common in this type of estimation. We find large, negative, and statistically meaningful effects of delinquent properties for which the local government has placed a tax lien and has put the lien up for sale to private investors. For properties with a tax lien that are not successfully sold, we estimate a negative spillover of 5.1% ($12,872) on surrounding properties. Properties with a tax lien that are sold to private investors have a smaller, but still negative impact on surrounding property values of 2.5% ($6310).