Cashing Out
Measuring the Cost of Bailouts
Deborah Lucas
Annual Review of Financial Economics, 2019, Pages 85-108
Abstract:
This review develops a theoretical framework that highlights the principles governing economically meaningful estimates of the cost of bailouts. Drawing selectively on existing cost estimates and augmenting them with new calculations consistent with this framework, I conclude that the total direct cost of the 2008 crisis-related bailouts in the United States was on the order of $500 billion, or 3.5% of GDP in 2009. The largest direct beneficiaries of the bailouts were the unsecured creditors of financial institutions. The estimated cost stands in sharp contrast to popular accounts that claim there was no cost because the money was repaid, and with claims of costs in the trillions of dollars. The cost is large enough to suggest the importance of revisiting whether there might have been less expensive ways to intervene to stabilize markets. At the same time, it is small enough to call into question whether the benefits of ending bailouts permanently exceed the regulatory burden of policies aimed at achieving that goal.
We Miss You George Bailey: The Effect of Local Banking Conditions on the County-Level Timing of the Great Recession
Maryann Feldman & Scott Langford
University of North Carolina Working Paper, December 2019
Abstract:
Community banks are the central financial institution in many places. They have the capacity to alleviate credit constraints of small firms. This may increase economic resilience, delaying or mitigating the effects of the Great Recession. We estimate how the county-level banking access and community bank market share affect both the timing and duration of the Great Recession. Using the Cox Proportional Hazards Model, we find that communities with a higher community bank market share are either less likely to experience recession conditions, or experience these conditions later. Using the Heckman Selection model, we confirm these results, and show that communities with a higher community bank market share are less likely to experience recession conditions. This research provides the first link between local financial institutions, and economic resilience.
The Long-Run Effects of Monetary Policy
Òscar Jordà, Sanjay Singh & Alan Taylor
NBER Working Paper, January 2020
Abstract:
Is the effect of monetary policy on the productive capacity of the economy long lived? Yes, in fact we find such impacts are significant and last for over a decade based on: (1) merged data from two new international historical databases; (2) identification of exogenous monetary policy using the macroeconomic trilemma; and (3) improved econometric methods. Notably, the capital stock and total factor productivity (TFP) exhibit hysteresis, but labor does not. Money is non-neutral for a much longer period of time than is customarily assumed. A New Keynesian model with endogenous TFP growth can reconcile all these empirical observations.
Impacts of Interest Rate Caps on the Payday Loan Market: Evidence from Rhode Island
Amir Fekrazad
Journal of Banking & Finance, forthcoming
Abstract:
Interest rate caps are the most common form of payday loan regulation, yet little academic research has examined their consequences. I investigate the impacts of tightening the cap from 15% to 10% in Rhode Island, using a difference-in-difference framework and a unique proprietary dataset of payday loans issued by major nationwide lenders between 2009 and 2013. Lenders always charge the prevailing cap, creating a sharp and clean variation in interest rate. I show that loan usage increases at the extensive and intensive margins, amounting to elasticity estimates in the range of 0.7-1.0. I also find that loan sequences become longer and more likely to end with default. No lenders exit the market, implying that market power existed. Furthermore, I find no evidence of credit rationing as a result of the lower cap. These changes imply an upper bound of $3.3 million per year for neoclassical consumer surplus. However, I show that behavioral consumers can be worse off by the policy if more than half of the increase in demand is due to overborrowing.
Effects of Fiscal Policy on Credit Markets
Alan Auerbach, Yuriy Gorodnichenko & Daniel Murphy
NBER Working Paper, January 2020
Abstract:
Credit markets typically freeze in recessions: access to credit declines and the cost of credit increases. A conventional policy response is to rely on monetary tools to saturate financial markets with liquidity. Given limited space for monetary policy in the current economic conditions, we study how fiscal stimulus can influence local credit markets. Using rich geographical variation in U.S. federal government contracts, we document that, in a local economy, interest rates on consumer loans decrease in response to an expansionary government spending shock.
Lending Next to the Courthouse: The Salience of Adverse Events and Mortgage Lending Decisions
Derek Huo, Mingzhu Tai & Yuhai Xuan
University of California Working Paper, November 2019
Abstract:
Adverse housing market events can affect credit conditions not only by hurting the financial fundamentals of banks, but may also by changing the lending behaviors of individual loan officers. In this paper, we test the latter mechanism by analyzing loan-level mortgage applications from 2008 to 2016 and utilizing a distinctive setup in the home foreclosure process: foreclosure auctions are typically held live at the county courthouse, thus making the county-wise foreclosures more salient to loan officers working nearby. By comparing lending outcomes across loan applications within the same county and across branches of the same bank, we find that mortgage lending standards are more stringent when the decisions are made in bank branches next to county courthouses, resulting in higher rejection rates and smaller approved loan size. Accordingly, aggregating at the branch level, credit supply is significantly tighter at bank branches next to the courthouses relative to other branches of the same bank within the same county. We show that this salience effect on lending decisions and credit supply increases in the county-wise foreclosure intensity, and these effects are especially pronounced among high-risk borrowers and for branches belonging to small-sized banks. Our results are not driven by fundamental differences in borrower and branch characteristics of neighborhoods next to the courthouses and remain robust in a matched sample of branches and loan applications. Overall, our findings provide micro-level evidence that adverse news can have significant impacts on credit market outcomes by changing the risk preferences and beliefs of individual financial decision makers.
How Quantitative Easing Works: Evidence on the Refinancing Channel
Marco Di Maggio, Amir Kermani & Christopher Palmer
Review of Economic Studies, forthcoming
Abstract:
We document the transmission of large-scale asset purchases by the Federal Reserve to the real economy using rich borrower-linked mortgage-market data and an identification strategy based on mortgage market segmentation. We find that central bank QE1 MBS purchases substantially increased refinancing activity, reduced interest payments for refinancing households, led to a boom in equity extraction, and increased aggregate consumption. Relative to QE-ineligible jumbo mortgages, QE-eligible conforming mortgage interest rates fell by an additional 40 bp and refinancing volumes increased by an additional 56% during QE1. We estimate that households refinancing during QE1 increased their durable consumption by 12%. Our results highlight that the transmission of unconventional monetary policy to the real economy depends crucially on the composition of assets purchased and the degree of segmentation in the market.
The Contribution of Foreign Holdings of U.S. Treasury Securities to the U.S. Long-Term Interest Rate
Enrique Martínez-García & Yixiang Zhang
Federal Reserve Working Paper, September 2019
Abstract:
We find robust empirical evidence of a structural break on the relationship between the foreign holdings of U.S. Treasury notes and bonds and the U.S. long-term interest rate likely occurring as monetary policy became constrained at the zero lower bound (ZLB) at the end of 2008. We argue that this can best be modelled in nonlinear form — based on a simple threshold single-equation error correction model with the federal funds rate as the threshold variable — which endogenously splits the sample into pre-ZLB and the ZLB regimes. Furthermore, we find that the estimated marginal effect of the foreign holdings ratio on the U.S. long-term interest rate is larger in absolute value during the ZLB regime than in the pre-ZLB regime, especially its long-run effect. Using the shadow federal funds rate derived from a Tobit-IV model, we find no significant structural break. Therefore, we argue that the ZLB is a leading cause of the perceived structural change. We take into account the concurrent impact of the Federal Reserve’s purchases of Treasury securities through a counterfactual assuming no Quantitative Easing (QE) interventions after 2008. Our results suggest that the three rounds of QE may have lowered the long-term interest rate by 38 to 55 basis points on average. We also find that changes in China’s holdings of U.S. Treasury notes and bonds played an important role in explaining the 2004-2006 interest rate conundrum and kept the long-term interest rate from going ever lower in the recent ZLB period.
Real Effects of Search Frictions in Consumer Credit Markets
Bronson Argyle, Taylor Nadauld & Christopher Palmer
NBER Working Paper, January 2020
Abstract:
We establish two underappreciated facts about costly search. First, unless demand is perfectly inelastic, search frictions can result in significant deadweight loss by decreasing consumption. Second, whenever cross-price elasticities are non-zero, costly search in one market also affects quantities in other markets. As predicted by our model of search for credit under elastic demand, we show that search frictions in credit markets contribute to price dispersion, affect loan sizes, and decrease final-goods consumption. Using microdata from millions of auto-loan applications and originations not intermediated by car dealers, we isolate plausibly exogenous variation in interest rates due to institution-specific pricing rules that price risk with step functions. These within-lender discontinuities lead to substantial variation in the benefits of search across lenders and distort extensive- and intensive-margin loan and car choices differentially in high- versus low-search-cost areas. Our results demonstrate real effects of the costliness of shopping for credit and the continued importance of local bank branches for borrower outcomes even in the mobile-banking era. More broadly, we conclude that costly search affects consumption in both primary and complementary markets.