Following the money
Clouded Judgment: The Role of Sentiment in Credit Origination
Kristle Cortés, Ran Duchin & Denis Sosyura
Journal of Financial Economics, forthcoming
Abstract:
Using daily fluctuations in local sunshine as an instrument for sentiment, we study its effect on day-to-day decisions of lower-level financial officers. Positive sentiment is associated with higher credit approvals, and negative sentiment has the opposite effect of a larger magnitude. These effects are stronger when financial decisions require more discretion, when reviews are less automated, and when capital constraints are less binding. The variation in approval rates affects ex post financial performance and produces significant real effects. Our analysis of the economic channels suggests that sentiment influences managers' risk tolerance and subjective judgment.
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How Do Bank Regulators Determine Capital-Adequacy Requirements?
Eric Posner
University of Chicago Law Review, Fall 2015, Pages 1853-1895
Abstract:
Regulators require banks to maintain capital above a certain level in order to correct the incentives to make excessively risky loans. However, it has never been clear how regulators determine how high or low the minimum capital–asset ratio should be. An examination of US regulators’ justifications for five regulations issued over more than thirty years reveals that regulators have never performed a serious economic analysis that would justify the levels that they have chosen. Instead, regulators appear to have followed a practice of incremental change designed to weed out a handful of outlier banks. This approach resulted in significant regulatory failures leading up to the financial crisis of 2007–2008.
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Hal Martin & Andrew Hanson
Regional Science and Urban Economics, July 2016, Pages 12–23
Abstract:
We simulate changes to metropolitan area home prices from reforming the Mortgage Interest Deduction (MID). Price simulations are based on an extended user cost model that incorporates two dimensions of behavioral change in home buyers: sensitivity of borrowing and the propensity to use tax deductions. We simulate prices with both inelastic and elastic supply. Our results show a wide range of price effects across metropolitan areas and prospective policies. Considering behavioral change and no supply elasticity, eliminating the MID results in average home price declines as steep as 13.5% in Washington, D.C., and as small as 3.5% in Miami-Fort Lauderdale, FL. Converting the MID to a 15 percent refundable credit reduces prices by as much as 1.4% in San Jose, CA, San Francisco, CA, and Washington, D.C. and increases average price in other metropolitan areas by as much as 12.1% (Miami-Fort Lauderdale). Accounting for market elasticities produces price estimates that are on average 36% as large as standard estimates.
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The Phillips Curve: Back to the '60s?
Olivier Blanchard
American Economic Review, May 2016, Pages 31-34
Abstract:
This paper reexamines the behavior of inflation and unemployment and reaches four conclusions: 1) The U.S. Phillips curve is alive and well (at least as well as in the past). 2) Inflation expectations however have become steadily more anchored. 3) The slope of the curve has substantially declined. But the decline dates back to the 1980s rather than to the crisis. 4) The standard error of the residual in the relation is large, especially in comparison to the low level of inflation. Each of the four conclusions presents challenges for the conduct of monetary policy.
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Weather-Adjusting Economic Data
Michael Boldin & Jonathan Wright
Brookings Papers on Economic Activity, Fall 2015, Pages 227-278
Abstract:
This paper proposes and implements a statistical methodology for adjusting employment data for the effects of deviations in weather from seasonal norms. This is distinct from seasonal adjustment, which controls only for the normal variation in weather across the year. We simultaneously control for both of these effects by integrating a weather adjustment step in the seasonal adjustment process. We use several indicators of weather, including temperature and snowfall. We find that weather effects can be important, shifting the monthly payroll change number by more than 100,000 in either direction. The effects are largest in the winter and early spring months and in the construction sector. A similar methodology is constructed and applied to data in the national income and product accounts (NIPA), although the manner in which NIPA data are reported makes it impossible to integrate weather and seasonal adjustments fully.
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Reactions of Equity Markets to Recent Financial Reforms
Nonna Sorokina & John Thornton
Journal of Economics and Business, forthcoming
Abstract:
We conduct event studies of broad equity market reaction to the events surrounding introduction and enactment of recent financial reform initiatives. In response to the introduction of the Dodd-Frank Act, financial firms and firms from a few other industries experience a statistically significant decrease in systematic risk, while a substantial number of industries, representing a broad cross-section of the economy, experiences a statistically significant increase in systematic risk. The systematic risk in some industries does not change. The increase in risk is concentrated in industries in which firms are dependent on external capital. The initial market reaction to Dodd-Frank indicates that it may lower the risk in financial firms, but the risk for many non-financial firms simultaneously increases.
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Joshua Hausman
Journal of Economic History, June 2016, Pages 427-477
Abstract:
This article shows that there were timing, geographic, and sectoral anomalies in the 1937/38 recession, none of which are easily explained by aggregate shocks. I argue that an auto industry supply shock contributed both to the recession's anomalies and to its severity. Labor-strife-induced wage increases and an increase in raw material costs led auto manufacturers to raise prices in fall 1937. Expectations of these price increases brought auto sales forward. When auto prices finally rose, sales plummeted. This shock likely reduced 1938 auto sales by roughly 600,000 units and 1938 GDP growth by 0.5–1 percentage point.
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Business Microloans for U.S. Subprime Borrowers
Cesare Fracassi et al.
Journal of Financial and Quantitative Analysis, February 2016, Pages 55-83
Abstract:
We show that business microloans to U.S. subprime borrowers have a very large impact on subsequent firm success. Using data on startup loan applicants from a lender that employed an automated algorithm in its application review, we implement a regression discontinuity design assessing the causal impact of receiving a loan on firms. Startups receiving funding are dramatically more likely to survive, enjoy higher revenues, and create more jobs. Loans are more consequential for survival among subprime business owners with more education and less managerial experience.
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Credit Rationing, Income Exaggeration, and Adverse Selection in the Mortgage Market
Brent Ambrose, James Conklin & Jiro Yoshida
Journal of Finance, forthcoming
Abstract:
We examine the role of borrower concerns about future credit availability in mitigating the effects of adverse selection and income misrepresentation in the mortgage market. We show that the majority of additional risk associated with “low-doc” mortgages originated prior to the Great Recession was due to adverse selection on the part of borrowers who could verify income but chose not to. We provide novel evidence that these borrowers were more likely to inflate or exaggerate their income. Our analysis suggests that recent regulatory changes that have essentially eliminated the low-doc loan product would result in credit rationing against self-employed borrowers.
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Joint Liability Lending and Credit Risk: Evidence from the Home Equity Market
Sumit Agarwal et al.
Journal of Housing Economics, June 2016, Pages 47–66
Abstract:
Using a unique dataset of home equity credit contracts, we examine the benefits of joint liability lending. Our results show that the risk of default for joint borrowers with similar risk scores is significantly lower than the risk associated with single borrowers. However, when joint borrowers have divergent risk scores, the risk of default is higher than single borrowers. Our results indicate that the lower risk associated with joint liability is largely dependent upon the similarity of risk characteristics (profiles) of the joint borrowers. Our results suggest that joint liability lending per say does not reduce credit risk.
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Will TLAC regulations fix the G-SIB too-big-to-fail problem?
Paul Kupiec
Journal of Financial Stability, forthcoming
Abstract:
The efficacy of the Financial Stability Board's proposed requirement for minimum “total loss absorbing capacity” (TLAC) at global systemically important banks (G-SIBs) is assessed using a stylized model of a bank holding company and an equilibrium asset pricing model to value financial claims. I identify a number of G-SIB strategies that satisfy minimum TLAC requirements but fail to reduce implicit safety net subsidies that accrue to G-SIB shareholders or increase the resources available to recapitalize a failing G-SIB subsidiary. To meet the FSB's stated goals, TLAC requirements must impose minimum TLAC at all subsidiaries and restrict how TLAC funds can be invested. An equivalent, but much simpler solution is to significantly increase regulatory capital requirements on systemically important bank subsidiaries.