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The Revolving Door for Financial Regulators
Sophie Shive & Margaret Forster
Review of Finance, July 2017, Pages 1445-1484
We investigate the motivations and effects of financial firms’ hiring of former US financial regulatory employees. The number of top executives with regulatory experience per firm has increased 24% over 2001–15, and hiring is associated with positive average announcement returns and a salary premium. In the quarter after hire, market and balance sheet measures of firm risk decrease significantly and measures of risk management activity increase, especially for hires from prudential regulators, who directly monitor financial firm risk. The absence of this result for unregulated firms and for exogenous shocks to regulatory experience suggests that firms hire ex-employees of their regulators when they perceive a need to reduce risk, consistent with a schooling hypothesis. We find little direct evidence of quid pro quo behavior in regulatory event frequency and fines.
Does Loan Officer Race Affect Mortgage Prices? Evidence from the Subprime Mortgage Market
Brent Ambrose, James Neil Conklin & Luis Lopez
Pennsylvania State University Working Paper, July 2017
We test for racial price discrimination in financial contracts using novel data from subprime mortgages that allow us to observe both parties to the contract. We find that minority borrowers pay over 8% more in fees, on average, than similar white borrowers. Minority borrowers, however, do not encounter any particular savings by obtaining a loan from a minority loan officer. Furthermore, white borrowers that work with minority loan officers pay fees similar to those minorities typically pay. These results contradict dogmatic expectations of animus-based discrimination but point to continued presence of price disparities.
Eliminating Conflicts of Interests in Banks: The Significance of the Volcker Rule
Sureyya Burcu Avci, Cindy Schipani & Nejat Seyhun
Yale Journal on Regulation, forthcoming
"Banks often attain insider trading status and become subject to insider trading reporting requirements and trading restrictions when they are hired to provide financial advice to their client firms. When banks become temporary insiders, they must also report all of these trades executed on Forms 3, 4, and 5 alongside other legal insiders. Using this insider trading database, we demonstrate that banks can and do access important, private, material information about their clients and trade on this information. On average, the inside information that banks acquire and trade on is highly valuable, allowing the banks to earn more on 25% on their proprietary trades. Furthermore, we find that relaxation and elimination of the Glass-Steagall restrictions allowed the banks to trade more frequently and earn greater amount of abnormal profits. Since 2002, banks tend to trade and earn more than 40% abnormal profits from adverse information about their client firms. Consequently, we demonstrate that an added benefit of enforcement of the Volcker Rule would be to eliminate the incentives to trade on material, non-public information about their clients by eliminating proprietary trading by banks. Thus, we argue that enforcing the Volcker Rule would also help contain some the current conflicts of interest in the banking system resulting from the elimination of Glass-Steagall restrictions."
Trading by Bank Insiders Before and During the 2007-2008 Financial Crisis
Journal of Financial Intermediation, forthcoming
This paper sheds new light on the role bank executives played in the financial crisis. It examines whether they foresaw the poor performance of their own bank by analyzing their insider trading patterns. Insider trading during 2006 predicts stock returns during the crisis: a portfolio strategy based on insider trading information earns a risk-adjusted return of over 40% during the crisis. Further, banks with a high exposure to the housing market and banks with a low exposure exhibit different insider trading patterns starting in mid-2006, when US housing prices first decline: insiders of high-exposure banks are 20% more likely to sell stock than insiders of low-exposure banks. This pattern is more pronounced for CEOs than other insiders. However, insider trading patterns of high- and low-exposure banks do not differ before 2006. Replacing high-exposure banks by too-big-too-fail banks yields similar results. This evidence indicates that insiders of high-exposure and too-big-too-fail banks revised their assessment of their banks’ investments following the reversal in the housing market.
Government Support of Banks and Bank Lending
William Bassett, Selva Demiralp & Nathan Lloyd
Journal of Banking & Finance, forthcoming
The extraordinary steps taken by governments during the 2007-2009 financial crisis to prevent the failure of large financial institutions and support credit availability have invited heated debate. This paper comprehensively reviews empirical assessments of the benefits of those programs — such as their effectiveness in reducing bank failures or supporting new lending — introduces a combined dataset of five key programs that provided term debt or equity to banks in the U.S., and assesses the effects of such support on lending by U.S. banks. The results, using an instrumental variable approach, suggest that bank loans did not increase at institutions receiving government support.
Who Needs Big Banks? The Real Effects of Bank Size on Outcomes of Large US Borrowers
Swarnava (Sonny) Biswas, Fabiana Gomez & Wei Zhai
Journal of Corporate Finance, October 2017, Pages 170-185
We examine how bank size affects borrowers, when information asymmetry is not particularly severe. Our sample comprises 20,806 loan facilities granted to 3,625 US public firms. After minimizing endogeneity concerns, we find that there is a positive relation between bank size and firm value, after the origination of the loan. Firms that borrow from large banks invest more, grow faster and have higher risk, proxied by earnings volatility. The effects are concentrated in borrowers which are ex-ante (pre-loan) safer (low leverage or high Z-Score) and muted, but not negative, in riskier firms. We highlight the bright side of large banks.
Get in Line: Chapter 11 Restructuring in Crowded Bankruptcy Courts
Management Science, forthcoming
Bankruptcy costs depend not only on the laws that govern financial distress but also on the ability of the court to rehabilitate distressed firms. This paper tests whether Chapter 11 restructuring outcomes are affected by time constraints in busy bankruptcy courts. Using the passage of the Bankruptcy Abuse Prevention and Consumer Protection Act as an exogenous shock to caseloads, I find that commercial banks report lower charge-offs on business lending when court caseloads decline, suggesting that the costs of financial distress are lower in less-congested courts. Further, court caseload affects how restructuring takes place. Less-busy bankruptcy judges liquidate fewer small firms, but more large firms. When caseload declines, large firms spend less time in court and firms that are dismissed from court are less likely to refile for bankruptcy. In addition, firms are less likely to sell assets or obtain debtor-in-possession financing in less-busy courts.
Bankruptcy and Cross-Country Differences in Productivity
Journal of Economic Behavior & Organization, forthcoming
For a sample of OECD countries, I document a systematic positive relationship between i) aggregate productivity, ii) the employment share by large firms and iii) the proportion of large firms in the economy. I propose that differences in bankruptcy procedures can explain this relationship. In a model of financial intermediation and informational frictions, I show that as bankruptcy procedures worsen — measured by the amount a lender can recover from bankrupt borrowers — lenders respond by i) shifting their portfolio of loans to smaller (less productive) firms and ii) lending less. This finding is supported by empirical evidence: across countries, efficient bankruptcy procedures are associated with a higher proportion of new bank loans allocated to large firms. In the model, moving the level of recovery rate from the U.S. level to that of the lowest recovery rate country in the OECD sample reduces TFP by around 30 percent.
Social Capital and Bank Stability
Justin Yiqiang Jin et al.
Journal of Financial Stability, forthcoming
Using a sample of public and private banks, we study how social capital relates to bank stability. Social capital, which reflects the level of cooperative norms in society, is likely to reduce opportunistic behavior (Jha and Chen 2015; Hasan et al., 2017) and, therefore, act as an informal monitoring mechanism. Consistent with our expectations, we find that banks in high social capital regions experienced fewer failures and less financial trouble during the 2007–2010 financial crisis than banks in low social capital regions. In addition, we find that social capital was negatively associated with abnormal risk-taking and positively associated with accounting transparency and accounting conservatism in the pre-crisis period of 2000–2006, indicating that risk-taking, accounting transparency, and accounting conservatism are possible channels through which social capital affected bank stability during the crisis.
The Impact of Price Controls in Two-Sided Markets: Evidence from US Debit Card Interchange Fee Regulation
Mark Manuszak & Krzysztof Wozniak
Federal Reserve Working Paper, July 2017
We study the pricing of deposit accounts following a regulation that capped debit card interchange fees in the United States and provide the first empirical investigation of the link between interchange fees and granular deposit account prices. This link is broadly predicted by the theoretical literature on two-sided markets, but the nature and magnitude of price changes are key empirical issues. To examine the ways that banks adjusted their account prices in response to the regulatory cap on interchange fees, we exploit the cap's differential applicability across banks and account types, while accounting for equilibrium spillover effects on banks exempt from the cap. Our results show that banks subject to the cap raised checking account prices by decreasing the availability of free accounts, raising monthly fees, and increasing minimum balance requirements, with different adjustment across account types. We also find that banks exempt from the cap adjusted prices as a competitive response to price changes made by regulated banks. Not accounting for such competitive responses underestimates the policy's impact on the market, for both banks subject to the cap and those exempt from it.
The Time-Varying Price of Financial Intermediation in the Mortgage Market
Andreas Fuster, Stephanie Lo & Paul Willen
NBER Working Paper, August 2017
The U.S. mortgage market links homeowners with savers all over the world. In this paper, we ask how much of the flow of money from savers to borrowers goes to the intermediaries that facilitate these transactions. Based on a new methodology and a new administrative dataset, we find that the price of intermediation, measured as a fraction of the loan amount at origination, is large — 142 basis points on average over the 2008–2014 period. At daily frequencies, intermediaries pass on price changes in the secondary market to borrowers in the primary market almost completely. At monthly frequencies, the price of intermediation fluctuates significantly and is highly sensitive to volume, likely reflecting capacity constraints: a one standard deviation increase in applications for new mortgages leads to a 30–35 basis point increase in the price of intermediation. Additionally, over 2008–2014, the price of intermediation increased about 30 basis points per year, potentially reflecting higher mortgage servicing costs and an increased legal and regulatory burden. Taken together, the sensitivity to volume and the positive trend led to an implicit total cost to borrowers of about $135 billion over this period. Finally, increases in application volume associated with “quantitative easing” (QE) led to substantial increases in the price of intermediation, which attenuated the benefits of QE to borrowers.
Credit Where Credit Is Due: Drivers of Subprime Credit
Elizabeth Anne Berger, Alexander Butler & Erik Mayer
Rice University Working Paper, June 2017
This paper uses individual credit histories to study how creditor-friendly repossession rights in auto lending affect borrowers. We examine the impact of auto repossessions on individuals in financial distress and find that repossessions increase the likelihood of bankruptcy and reduce future access to credit. Results from a quasi-experimental setting show that bankruptcy rates double in states with creditor-friendly repossession rights, compared to states with more borrower protection. Our findings suggest that creditors’ rights have broad, negative effects on marginal borrowers that extend beyond merely losing a collateralized asset.
Advertising, consumer awareness, and choice: Evidence from the U.S. banking industry
Elisabeth Honka, Ali Hortaçsu & Maria Ana Vitorino
RAND Journal of Economics, Fall 2017, Pages 611–646
How does advertising influence consumer decisions and market outcomes? We utilize detailed data on consumer shopping behavior and choices over bank accounts to investigate the effects of advertising on the different stages of the shopping process: awareness, consideration, and choice. We formulate a structural model with costly search and endogenous consideration sets, and show that advertising in the U.S. banking industry is primarily a shifter of awareness as opposed to consideration or choice. Advertising makes consumers aware of more options, search more, and find better alternatives. This increases the market share of smaller banks and makes the industry more competitive.