Follow all the money

Kevin Lewis

July 10, 2018

Complex Mortgages
Gene Amromin et al.
Review of Finance, forthcoming


Complex mortgages became a popular borrowing instrument during the bullish housing market of the early 2000s but vanished rapidly during the subsequent downturn. These non-traditional loans, including interest-only and negative-amortization mortgages, enable households to postpone loan repayment in contrast to fully-amortizing traditional mortgages. Contrary to common perception, complex mortgages are used by households with high income levels and prime credit scores, quite unlike the low-income population targeted by subprime mortgages. Nonetheless, we find that complex-mortgage borrowers become delinquent on their mortgages at rates twice as high as borrowers with plain-vanilla fixed-rate contracts even after controlling for household and loan characteristics. Our findings suggest a link between innovations in mortgage markets focused on prime borrowers and the financial crisis.

Internet Rising, Prices Falling: Measuring Inflation in a World of E-Commerce
Austan Goolsbee & Peter Klenow
NBER Working Paper, May 2018


We use Adobe Analytics data on online transactions for millions of products in many different categories from 2014 to 2017 to shed light on how online inflation compares to overall inflation, and to gauge the magnitude of new product bias online. The Adobe data contain transaction prices and quantities purchased. We estimate that online inflation was about 1 percentage point lower than in the CPI for the same categories from 2014-2017. In addition, the rising variety of products sold online, implies roughly 2 percentage points lower inflation than in a matched model/CPI-style index.

The Capitalization of Consumer Financing into Durable Goods Prices
Bronson Argyle et al.
NBER Working Paper, June 2018 


A central question in the study of business cycles and credit is the relationship between asset prices and borrowing conditions. In this paper, we investigate the effects of cross-sectional credit-supply shocks on the prices of durable goods. Understanding how prices capitalize credit in the cross-section is important for understanding the incidence, transmission, and aggregation of credit-supply shocks. Using loan-level data on the prices paid for used cars by millions of borrowers and hundreds of auto-loan lenders, we measure what happens to individual-level prices when only some borrowers are exposed to an exogenous shock to the user cost of credit. Holding car quality fixed with a battery of age-make-model-trim by month fixed effects, we document that loan maturity is capitalized into the price treated borrowers pay for identical cars, attenuating the benefit of cheaper financing. For a car buyer with an annual discount rate less than 8.9%, the benefits of being offered cheaper credit are more than offset by the higher purchase price of the car. Overall, our estimates suggest that one additional year of loan maturity is worth 2.8% of the car’s purchase price, an implied elasticity of price with respect to monthly payment size of -0.23.

A Skeptical View of the Impact of the Fed's Balance Sheet
David Greenlaw et al.
NBER Working Paper, June 2018


We review the recent U.S. monetary policy experience with large scale asset purchases (LSAPs) and draw lessons for monetary policy going forward. A rough consensus from previous studies is that LSAP purchases reduced yields on 10-year Treasuries by about 100 basis points. We argue that the consensus overstates the effect of LSAPs on 10-year yields. We use a larger than usual population of possible events and exploit interpretations provided by the business press. We find that Fed actions and announcements were not a dominant determinant of 10-year yields and that whatever the initial impact of some Fed actions or announcements, the effects tended not to persist. In addition, the announcements and implementation of the balance-sheet reduction do not seem to have affected rates much. Going forward, we expect the Federal Reserve’s balance sheet to stay large. This calls for careful consideration of the maturity distribution of assets on the Fed’s balance sheet. Our conclusion is that the most important and reliable instrument of monetary policy is the short term interest rate, and we discuss the implications of this finding for Fed policy going forward.

An examination of bank behavior around Federal Reserve stress tests
Marcia Millon Cornett et al.
Journal of Financial Intermediation, forthcoming


Examining bank behavior around Federal Reserve stress tests, we find that stress test banks increase capital ratios at the starting point for annual stress testing significantly more than non-stress test banks. These trends are completely reversed (and economically significant) in the other quarters. Further, the differences between stress test and non-stress test banks seen in stress test years do not occur in 2010, when the Fed did not conduct a stress test. Results show that, as they enter the stress test, stress test banks lower dividends significantly more than non-stress test banks. Finally, stress test banks spend significantly more on lobbying than non-stress test banks. The results suggest that stress test banks may be managing financial performance and investing in political spending to improve their chances of passing stress tests.

Corporate Governance of Banks and Financial Stability
Deniz Anginer et al.
Journal of Financial Economics, forthcoming


We find that shareholder-friendly corporate governance is associated with higher stand-alone and systemic risk in the banking sector. Specifically, shareholder-friendly corporate governance results in higher risk for larger banks and for banks that are located in countries with generous financial safety nets as banks try to shift risk toward taxpayers. We confirm our findings by comparing banks to nonfinancial firms and examining changes in bank risk around an exogenous regulatory change in governance. Our results underline the importance of the financial safety net and too-big-to-fail guarantees in thinking about corporate governance reforms at banks.

Effects of Government Bailouts on Mortgage Modification
Sumit Agarwal & Yunqi Zhang
Journal of Banking & Finance, August 2018, Pages 54-70


This paper shows how liquidity infusions affect loan modification in the mortgage market. The design of pooling and servicing agreements leads mortgage servicers to prefer foreclosure over modification when they are liquidity constrained. Therefore, a positive liquidity shock is expected to boost modification rates. Using a residential mortgage dataset that includes loan-level information, we find that the Troubled Asset Relief Program significantly increased the modification rate. Our findings help us better understand the economic consequences of government intervention and have important policy implications for the renegotiation of distressed mortgages.

What’s the Catch? Suspicion in Bank Motives and Sluggish Refinancing
Eric Johnson, Stephan Meier & Olivier Toubia
Review of Financial Studies, forthcoming


Failing to refinance a mortgage can cost a borrower thousands of dollars. Based on administrative data from a large financial institution, we show that around 50% of borrowers leave thousands of dollars on the table by not refinancing. Survey data indicate that, among all the behavioral factors examined, only suspicion of banks motives is consistently related to the probability of accepting a refinancing offer. Finally, we report the results of three field experiments showing that enticing offers made by banks fail to increase participation and may even deepen suspicion. Our findings highlight the important role of trust in financial decisions.

Threat of Entry and the Use of Discretion in Banks’ Financial Reporting
Rimmy Tomy
Journal of Accounting and Economics, forthcoming


This paper studies managers’ use of accounting discretion to deter entry. Using state-level changes in branching regulation under the Interstate Banking and Branching Efficiency Act, I find geographically-constrained community banks increased their loan loss provisions to appear less profitable when faced with the threat of entry by competitors. Additional tests rule out alternative explanations that firm economics or regulators drove the increase. I complement my analyses with survey-based evidence. Findings from the survey confirm that banks prefer to locate in markets where incumbents have high profitability and low credit losses, and that banks use competitors’ financial statements to analyze competition.

Government Guarantees and the Valuation of American Banks
Andrew Atkeson et al.
NBER Working Paper, June 2018


Banks' ratio of the market value to book value of their equity was close to 1 until the 1990s, then more than doubled during the 1996-2007 period, and fell again to values close to 1 after the 2008 financial crisis. Sarin and Summers (2016) and Chousakos and Gorton (2017) argue that the drop in banks' market-to-book ratio since the crisis is due to a loss in bank franchise value or profitability. In this paper we argue that banks' market-to-book ratio is the sum of two components: franchise value and the value of government guarantees. We empirically decompose the ratio between these two components and find that a large portion of the variation in this ratio over time is due to changes in the value of government guarantees.

When the Fed Speaks: Arguments, Emotions, and the Microfoundations of Institutions
Derek Harmon
Administrative Science Quarterly, forthcoming


This study investigates what happens when a prominent leader explicitly reaffirms the taken-for-granted assumptions underlying an institution. While such efforts are usually made to reinforce the institution, I theorize that they actually destabilize the institution and create collective uncertainty by reopening the very considerations that people take for granted. Using speeches made by the chair of the United States Federal Reserve from 1998 to 2014, I demonstrate that reaffirming the taken-for-granted assumptions underlying the monetary policy framework creates uncertainty in the broader financial market. This market reaction is also influenced by emotions present at the time of the speech that shape how the event is interpreted. Speeches conveyed in an overall more positive tone suppress this reaction, while more fear in the business media amplifies it. Moreover, supplementary analyses conducted on speeches during the financial crisis suggest that when the taken-for-grantedness of these assumptions has weakened, reaffirming them no longer creates uncertainty to the same extent. This study expands our understanding of the consequences of communication in market contexts, raises important questions about the trade-offs between public transparency and market stability, and contributes new insights to research on the cognitive and emotional microfoundations of institutions.

The Evolving Complexity of Capital Regulation
Richard Herring
Journal of Financial Services Research, June 2018, Pages 183-205


This article traces the growing complexity of capital regulation with emphasis on decisions of the Basel Committee on Banking Supervision and bank regulators in the US. The pattern is one of increasingly complex regulations as each round of reform attempts to correct perceived weaknesses in the earlier regime. The outcome is a regulatory framework that is remarkably opaque, costly to monitor and enforce, and imposes heavy compliance costs on the regulatees, which are inevitably passed on in part to users of financial services. After a discussion of the most recent round of reforms, the article presents a table organized by five different regulatory capital numerators and five different denominators that define thirtynine different regulatory capital requirements, which Globally Significant US banks must meet. This way of organizing the various capital requirements shows how the number of capital ratios could be reduced by 75% with no loss of rigor. The conclusion speculates about why regulatory simplification seems so much more difficult to accomplish in the US than in other countries with much longer regulatory traditions.

The Effect of the Fed's Large‐Scale Asset Purchases on Inflationary Expectations
Willem Thorbecke
Southern Economic Journal, forthcoming


In 2008 U.S. demand collapsed and triggered deflation. The Fed employed large‐scale asset purchases (LSAP) to fight deflation. How did news of LSAP affect inflationary expectations? If investors believed that LSAP would raise inflation, they would sell assets exposed to inflation and purchase inflation hedges. This would lower the prices of assets that are harmed by inflation and raise the prices of assets that benefit from inflation. Examining the relationship between asset price changes and inflation sensitivities can thus shed light on how financial markets process LSAP news. Results across 60 assets indicate that initially LSAP announcements lowered expected inflation. Only as inflation approached its target did news of LSAP raise expected inflation.

Judging Judicial Foreclosure
Brian Feinstein
Journal of Empirical Legal Studies, June 2018, Pages 406-451


For the third time in the last several decades, policymakers are contemplating an overhaul of mortgage‐finance regulations. Despite the considerable attention paid to how ex ante regulations affect the availability of credit and the appropriateness of the mortgage products that lenders offer, however, our understanding of how the legal framework governing foreclosures - a form of ex post borrower protection - affects mortgage lending is incomplete. Leveraging data on loan applicants that are geographically proximate and subject to the same federal mortgage‐finance regulations and nearly identical state foreclosure regimes - but for the presence or absence of a judicial foreclosure requirement - this analysis enables the identification of the independent effects of judicial‐foreclosure requirements on loan approval decisions and the share of approved applicants who are offered subprime loans. I find that lenders adopt a more conservative posture in evaluating loan applications in jurisdictions where they must haul delinquent borrowers into court. All else equal, loan applications are less likely to be approved and approved borrowers are less likely to be offered subprime loans in judicial‐foreclosure states. Further, some models indicate that these results may be amplified for borrowers with lower socioeconomic status, suggesting that judicial supervision of foreclosures may have tempered one of the more flagrant practices of the subprime era: providing high‐rate mortgages with a greater likelihood of default to lower‐income and minority borrowers. These results suggest that, in contemplating changes to the regulation of mortgage lenders, policymakers should consider state foreclosure law to be among the tools in their regulatory toolkit.

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