Loaners
Neil Fligstein & Alexander Roehrkasse
American Sociological Review, August 2016, Pages 617-643
Abstract:
The financial crisis of 2007 to 2009 was marked by widespread fraud in the mortgage securitization industry. Most of the largest mortgage originators and mortgage-backed securities issuers and underwriters have been implicated in regulatory settlements, and many have paid multibillion-dollar penalties. This article seeks to explain why this behavior became so pervasive. We evaluate predominant theories of white-collar crime, finding that theories emphasizing deregulation or technical opacity identify only necessary, not sufficient, conditions. Our argument focuses instead on changes in competitive conditions and firms’ positions within and across markets. As the supply of mortgages began to decline around 2003, mortgage originators lowered credit standards and engaged in predatory lending to shore up profits. In turn, vertically integrated mortgage-backed securities issuers and underwriters committed securities fraud to conceal this malfeasance and enhance the value of other financial products. Our results challenge several existing accounts of how widespread the fraud should have been and, given the systemic crimes that occurred, which financial institutions were the most likely to commit fraud. We consider the implications of our results for regulations that were based on some of these models. We also discuss the overlooked importance of illegal behavior for the sociology of markets.
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The Fed and Lehman Brothers: Introduction and Summary
Laurence Ball
NBER Working Paper, July 2016
Abstract:
Why did the Federal Reserve let Lehman Brothers fail? Fed officials say they lacked the legal authority to rescue the firm, because it did not have adequate collateral to borrow the cash it needed. This paper summarizes a monograph that disputes officials’ claims (Ball, 2016). These claims are incorrect in two senses: a perceived lack of legal authority was not why the Fed did not rescue Lehman; and the Fed did in fact have the authority for a rescue.
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Subprime Mortgage Default in Minority Neighborhoods
Robert Connolly
University of North Carolina Working Paper, May 2016
Abstract:
In this paper, we empirically examine differences in subprime borrower default decisions by Census tract characteristics in order to clarify how the subprime foreclosure crisis played out in minority areas. An innovation in our modeling approach is that we do not constrain the impact of neighborhood composition to be identical across diverse decision-making settings. Rather, we focus on variation in decision-making when the option to default is more likely to be in the money. Carefully controlling for dynamic loan balances and home values, as well as other loan characteristics and economic conditions, we find that borrowers in minority neighborhoods, delineated by Census tracts, were less likely to default at high contemporaneous, combined loan to value ratios (CLTV) than those in neighborhoods with fewer minorities. Borrowers in tracts with a greater share of recent immigrants where overall mobility is greater are more likely to default at high CLTVs, however. Our finding that subprime borrowers in minority neighborhoods have a lower propensity to default at high CLTV stands in contrast to assertions that households in these neighborhoods may have been more willing to strategically default, that is, to default when equity turned negative regardless of their ability to repay. By contrast, our findings show that borrowers in white neighborhoods were more likely to default when they had relatively higher negative equity.
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Time Preferences and Mortgage Choice
Stephen Atlas et al.
Journal of Marketing Research, forthcoming
Abstract:
Mortgage decisions have important consequences for consumers, lenders, and the state of the economy more generally. Mortgage decisions are also prototypical of consumer financial choices that involve a stream of expenditures and consumption occurring across time. The authors use heterogeneity in time preferences, for both immediate (present bias) and long-term outcomes, to explain a sequence of mortgage decisions, including mortgage choice and the decision to abandon a mortgage. The authors employ an analytic model and a survey of mortgaged households augmented by zip-code level house price and foreclosure data. The model suggests and data confirms that consumers with greater present bias and long term discounting will tend to choose mortgages that minimize up-front costs. However, greater present bias decreases homeowners' willingness to abandon a mortgage, locking them into the contract. Long term patience increases abandonment. This reversal across mortgage decisions is difficult for alternate accounts to explain. These results suggest that a two-parameter model of time preferences is helpful for understanding how homeowners make mortgage decisions.
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Jaromir Nosal & Guillermo Ordoñez
Journal of Monetary Economics, June 2016, Pages 124–140
Abstract:
When governments cannot commit to not providing bailouts, banks may take excessive risks and generate crises. At the outbreak of a financial crisis, however, governments are usually uncertain about its systemic nature, and may delay intervention to learn more from endogenous market outcomes. We show such delay introduces strategic restraint: banks restrict their portfolio riskiness relative to their peers to avoid being the worst performers and bearing the costs of delay. Hence, uncertainty has the potential to self-discipline banks and mitigate crises in the absence of commitment. We study the effects of standard regulations on these novel forces.
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Limited Deposit Insurance Coverage and Bank Competition
Oz Shy, Rune Stenbacka & Vladimir Yankov
Journal of Banking & Finance, October 2016, Pages 95–108
Abstract:
Deposit insurance designs in many countries place a limit on the coverage of deposits in each bank. However, no limits are placed on the number of accounts held with different banks. Therefore, under limited deposit insurance, some consumers open accounts with different banks to achieve higher or full deposit insurance coverage. We compare three regimes of deposit insurance: No deposit insurance, unlimited deposit insurance, and limited deposit insurance. We show that limited deposit insurance weakens competition among banks and reduces total welfare relative to no or unlimited deposit insurance.
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Information Frictions in Uncertain Regulatory Environments: Evidence from U.S. Commercial Banks
Kristin Wilson & Stan Veuger
Oxford Bulletin of Economics and Statistics, forthcoming
Abstract:
Information frictions between firms and regulators are typically seen as a means by which firms evade enforcement. In contrast, we argue that information frictions between firms and regulators can reduce the efficiency of firms’ compliance efforts when the interpretation of regulatory standards is uncertain. We exploit plausibly exogenous variation in distance between firms and their regulators to demonstrate this for a panel of community banks in the US. We find that banks located at greater distance from regulatory field offices face significantly higher administrative costs, at a rate of 20% of administrative costs per hour of travel time. These differences do not come with reduced compliance, are not driven by endogenous regulator choice, and are stable over time. Further, the costs borne by distant firms are negatively related to the scale of the jurisdiction in which they operate, suggesting that information spillovers between firms limit uncertainty about regulatory expectations.
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Is Bigger Necessarily Better in Community Banking?
Joseph Hughes, Julapa Jagtiani & Loretta Mester
Federal Reserve Working Paper, June 2016
Abstract:
We investigate the relative performance of publicly traded community banks (those with assets less than $10 billion) versus larger banks (those with assets between $10 billion and $50 billion). A body of research has shown that community banks have potential advantages in relationship lending compared with large banks, although newer research suggests that these advantages may be shrinking. In addition, the burdens placed on community banks by the regulatory reforms mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act and the need to increase investment in technology, both of which have fixed-cost components, may have disproportionately raised community banks’ costs. We find that, on average, large banks financially outperform community banks as a group and are more efficient at credit-risk assessment and monitoring. But within the community bank segment, larger community banks outperform smaller community banks. Our findings, taken as a whole, suggest that there are incentives for small banks to grow larger to exploit scale economies and to achieve other scale-related benefits in terms of credit-risk monitoring. In addition, we find that small business lending is an important factor in the better performance of large community banks compared with small community banks. Thus, concern that small business lending would be adversely affected if small community banks find it beneficial to increase their scale is not supported by our results.
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The Effects of Usury Laws on Higher-Risk Borrowers
Colleen Honigsberg, Robert Jackson & Richard Squire
Columbia University Working Paper, May 2016
Abstract:
In this Article, we exploit a natural experiment -- an unexpected judicial decision -- to study the effects of state usury laws on consumer loans to higher-risk borrowers. In May 2015, the U.S. Court of Appeals for the Second Circuit issued a decision that, in effect, switched on the usury laws of three States, rendering those laws enforceable against owners of consumer loans that had previously been issued under the expectation that the usury laws were preempted by federal statute. Using proprietary data from three marketplace lending platforms, we study the decision’s effect on consumer credit markets. We find that the court’s decision significantly impaired credit availability for riskier borrowers, shrinking loan issuances to borrowers with the lowest FICO scores. We see no evidence, however, of strategic defaults by borrowers in these markets, despite the fact that the decision suggests that their loans are unenforceable. We also examine secondary market trading in notes backed by non-current, potentially usurious loans in the Second Circuit, and find that the decision reduced the prices of those notes. We do not, however, find evidence of a similar price decrease for notes backed by potentially usurious loans that the borrower continues to pay on time - suggesting that investors do not anticipate an increase in strategic defaults as a result of the court’s decision.
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For Better and for Worse Effects of Access to High-Cost Consumer Credit
Christine Dobridge
Federal Reserve Working Paper, July 2016
Abstract:
I provide empirical evidence that the effect of high-cost credit access on household material well-being depends on if a household is experiencing temporary financial distress. Using detailed data on household consumption and location, as well as geographic variation in access to high cost payday loans over time, I find that payday credit access improves wellbeing for households in distress by helping them smooth consumption. In periods of temporary financial distress — after extreme weather events like hurricanes and blizzards — I find that payday loan access mitigates declines in spending on food, mortgage payments, and home repairs. In an average period, however, I find that access to payday credit reduces well-being. Loan access reduces spending on nondurable goods overall and reduces housing- and food-related spending particularly. These results highlight the state dependent nature of the effects of high-cost credit as well as the consumption-smoothing role that it plays for households with limited access to other forms of credit.
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Securitization and Mortgage Default
Ronel Elul
Journal of Financial Services Research, June 2016, Pages 281-309
Abstract:
We find that private-securitized loans perform worse than observably similar, nonsecuritized loans, which provides evidence for adverse selection. The effect of securitization is strongest for prime mortgages, which have not been studied widely in the previous literature and, in particular, prime adjustable-rate mortgages (ARMs): These become delinquent at a 30 % higher rate when privately securitized. By contrast, our baseline estimates for subprime mortgages show that private-securitized loans default at lower rates. We demonstrate, however, that “early defaulting loans” account for this: those that were so risky that they defaulted before they could be securitized.