Money trail
Fernando Ferreira & Joseph Gyourko
NBER Working Paper, June 2015
Abstract:
Utilizing new panel micro data on the ownership sequences of all types of borrowers from 1997-2012 leads to a reinterpretation of the U.S. foreclosure crisis as more of a prime, rather than a subprime, borrower issue. Moreover, traditional mortgage default factors associated with the economic cycle, such as negative equity, completely account for the foreclosure propensity of prime borrowers relative to all-cash owners, and for three-quarters of the analogous subprime gap. Housing traits, race, initial income, and speculators did not play a meaningful role, and initial leverage only accounts for a small variation in outcomes of prime and subprime borrowers.
---------------------
Claudia Lambert, Felix Noth & Ulrich Schüwer
Journal of Financial Intermediation, forthcoming
Abstract:
This paper tests whether an increase in insured deposits causes banks to become more risky. We use variation introduced by the U.S. Emergency Economic Stabilization Act in October 2008, which increased the deposit insurance coverage from $100,000 to $250,000 per depositor and bank. For some banks, the amount of insured deposits increased significantly; for others, it was a minor change. Our analysis shows that the more affected banks increase their investments in risky commercial real estate loans and become more risky relative to unaffected banks following the change. This effect is most distinct for affected banks that are low capitalized.
---------------------
Ex Ante CEO Severance Pay and Risk-Taking in the Financial Services Sector
Kareen Brown, Ranjini Jha & Parunchana Pacharn
Journal of Banking & Finance, October 2015, Pages 111–126
Abstract:
We examine 533 CEO severance contracts for financial services firms from 1997 to 2007 and find that ex-ante severance pay is positively associated with risk-taking after controlling for the incentive effects provided by equity-based compensation. We report a positive causal relation between the amount of severance pay and risk-taking using popular market-based risk measures as well as distance-to-default and the Z-score. We also find that severance pay encourages excessive risk-taking using metrics such as tail risk and asset quality. Our results are consistent with the risk-shifting argument and provide support for recent reforms on severance pay in the financial sector.
---------------------
Loan Originations and Defaults in the Mortgage Crisis: Further Evidence
Manuel Adelino, Antoinette Schoar & Felipe Severino
NBER Working Paper, July 2015
Abstract:
This paper addresses two critiques by Mian and Sufi (2015a, 2015b) that were released in response to the results documented in Adelino, Schoar and Severino (2015). We confirm that none of the results in our previous paper are affected by the issues put forward in these critiques; in particular income overstatement does not drive any of our results. Our analysis shows that the origination of purchase mortgages increased across the whole income distribution during the 2002-2006 housing boom, and did not flow disproportionately to low-income borrowers. In addition, middle- and high-income, as well as middle- and high-credit-score borrowers (not the poor), represent a larger fraction of delinquencies in the crisis relative to earlier periods. The results are inconsistent with the idea that distortions in the origination of credit caused the housing boom and the crisis and are more consistent with an expectations-based view where both home buyers and lenders were buying into increasing housing values and defaulted once prices dropped.
---------------------
Deregulation, Competition and the Race to the Bottom
Marco Di Maggio, Amir Kermani & Sanket Korgaonkar
Columbia University Working Paper, March 2015
Abstract:
We take advantage of the pre-emption of national banks from state anti-predatory lending laws as a quasi-experiment to study the effect of deregulation and its interaction with competition on the supply of complex mortgages (interest only, negative amortization, and teaser mortgages). We first show that following the pre-emption ruling, national banks significantly increased their origination of loans with prepayment penalties and negative amortization features, relative to non-OCC regulated lenders, and lenders in states without anti-predatory lending laws. This increase in the supply of complex mortgages is significantly more pronounced for banks that poorly performed in the previous quarters. Further, we highlight a competition channel: first, a higher degree of competition induce OCC lenders to originate more riskier loans; second, in counties where OCC regulated lenders had larger market share prior to the pre-emption, even non-OCC lenders responded by increasing the presence of predatory terms to the extent permitted by the state anti-predatory lending laws. Overall, our evidence is suggestive that the deregulation of credit markets ignited a "race to the bottom" among distressed financial institutions, working through the competition between lenders.
---------------------
Household Debt and Defaults from 2000 to 2010: Facts from Credit Bureau Data
Atif Mian & Amir Sufi
NBER Working Paper, May 2015
Abstract:
We use individual level credit bureau data to document which individuals saw the biggest rise in household debt from 2000 to 2007 and the biggest rise in defaults from 2007 to 2010. Growth in household debt from 2000 to 2007 was substantially larger for individuals with the lowest initial credit scores. However, initial debt levels were lower for individuals in the lowest 20% of the initial credit score distribution. As a result, the contribution to the total dollar rise in household debt was strongest among individuals in the 20th to 60th percentile of the initial credit score distribution. Consistent with the importance of home-equity based borrowing, the increase in debt is especially large among individuals in the lowest 60% of the credit score distribution living in high house price growth zip codes. In contrast, the borrowing of individuals in the top 20% of the credit score distribution is completely unresponsive to higher house price growth. In terms of defaults, the evidence is unambiguous: both default rates and the share of total delinquent debt is largest among individuals with low initial credit scores. The bottom 40% of the credit score distribution is responsible for 73% of the total amount of delinquent debt in 2007, and 68% of the total in 2008. Individuals in the top 40% of the initial credit score distribution never make up more than 15% of total delinquencies, even in 2009 at the height of the default crisis.
---------------------
How Does Executive Compensation Affect Bank Risk Taking: Evidence from FAS 123R
Yongqiang Chu & Tao Ma
University of South Carolina Working Paper, June 2015
Abstract:
We examine how executive compensation affects bank risk taking in mortgage lending using exogenous variations in stock option grants generated by the FAS 123R, which requires all firms to expense options. Using a difference-in-differences approach, we find that banks that did not expense options before FAS 123R (treated firms) significantly decreases their approval rates of risky mortgage applications after FAS 123R relative to banks that did not grant stock options or voluntarily expensed their stock option before FAS 123R (control banks). We also find that the treatment effect is concentrated in large banks, suggesting that executives’ risk-taking incentives at large banks are more sensitive to option compensation. This is consistent with the idea that government implicit guarantee on too-big-to-fail banks encourages bank risk-taking. Lastly, we show that treatment banks are more likely than control banks to reduce their exposure to risky mortgage loans through securitization after FAS 123R. Overall, we provide consistent evidence that executive option compensation affects mortgage lending practices in financial institutions, which eventually contributes to the 2008-2009 financial crisis.
---------------------
Does Bankruptcy Law Affect Business Turnover? Evidence from New and Existing Business
Shawn Rohlin & Amanda Ross
Economic Inquiry, forthcoming
Abstract:
This study examines how differences in state bankruptcy laws, specifically the homestead exemption, affect business turnover by studying both new and existing businesses. We focus on areas just near state boundaries to control for unobserved local attributes to better isolate the effect of more wealth protection. We find that an increase in the homestead exemption attracts new businesses but also has a positive impact on existing businesses, suggesting that asset protection through bankruptcy law encourages successful entrepreneurs to incur the risks. Our results indicate that the personal bankruptcy law is an important policy tool that governments can use to encourage business growth without causing business turnover.
---------------------
Risk and Risk Management in the Credit Card Industry
Florentin Butaru et al.
NBER Working Paper, June 2015
Abstract:
Using account level credit-card data from six major commercial banks from January 2009 to December 2013, we apply machine-learning techniques to combined consumer-tradeline, credit-bureau, and macroeconomic variables to predict delinquency. In addition to providing accurate measures of loss probabilities and credit risk, our models can also be used to analyze and compare risk management practices and the drivers of delinquency across the banks. We find substantial heterogeneity in risk factors, sensitivities, and predictability of delinquency across banks, implying that no single model applies to all six institutions. We measure the efficacy of a bank’s risk-management process by the percentage of delinquent accounts that a bank manages effectively, and find that efficacy also varies widely across institutions. These results suggest the need for a more customized approached to the supervision and regulation of financial institutions, in which capital ratios, loss reserves, and other parameters are specified individually for each institution according to its credit-risk model exposures and forecasts.
---------------------
State Bankruptcy Laws and the Responsiveness of Credit Card Demand
Amanda Dawsey
Journal of Economics and Business, September–October 2015, Pages 54–76
Abstract:
The responsiveness of credit demand to interest rate changes may vary widely by state due to differences in state bankruptcy and insolvency laws. Bankruptcy exemptions and other state laws insulate borrowers against negative consequences from non-repayment, and so lenient regulations may lead to decreased responsiveness to interest rate increases. Lenient laws also decrease creditors’ incentive to lend, and a resulting decrease in loan options will reinforce the inelasticity of credit demand. This paper presents a model that predicts (1) that credit demand is less responsive in states with borrower-friendly, lenient bankruptcy and insolvency laws, and (2) the effects of state laws on demand elasticity will be strongest among borrowers facing credit constraints. Using market experiment data from a large credit card issuer, this paper presents evidence that supports the hypothesis that demand responsiveness and insolvency law leniency are negatively related. Borrowers are more likely to continue using a card in states with lenient exemption and garnishment laws. Borrowers who take up less attractive offers are more likely to be credit constrained; among these borrowers, the impact of exemption laws is much stronger than among the unconstrained group.
---------------------
Eugene White
NBER Working Paper, July 2015
Abstract:
During the 1920-1921 recession, the Federal Reserve Bank of Atlanta resisted the deflationary policy sanctioned by the Federal Reserve Board and pursued by other Reserve banks. By borrowing gold reserves from other Reserve banks, it facilitated a reallocation of liquidity to its district during the contraction. Viewing the collapse of the price of cotton, the dominant crop in the region, as a systemic shock to the Sixth District, the Atlanta Fed increased discounting and enabled capital infusions to aid its member banks. The Atlanta Fed believed that it had to limit bank failures to prevent a fire sale of cotton collateral that would precipitate a general panic. In this previously unknown episode, the Federal Reserve Board applied considerable pressure on the Atlanta Fed to adhere to its policy and follow a simple Bagehot-style rule. The Atlanta Fed was vindicated when the shock to cotton prices proved to be temporary, and the Board conceded that the Reserve Bank had intervened appropriately.
---------------------
Bankruptcy Discharge and the Emergence of Debtor Rights in Eighteenth Century England
Ann Carlos, Edward Kosack & Luis Castro Penarrieta
University of Colorado Working Paper, May 2015
Abstract:
Bankruptcy is a precise legal process defining the rules when debtor fails to repay their debts. These rules determine willingness to lend and to borrow and thus can affect economic growth. In 1706, the English Parliament passed a bankruptcy statute that provided potential rights for bankrupts and represents a fundamental change in the rules regarding bankruptcy. Where previously a bankrupt could exit bankruptcy only upon full repayment of debts, creditors could now choose to discharge a bankrupt prior to full repayment of his debts. In this paper, we develop a simple model to explore why creditors might discharge a bankrupt, and conduct an empirical analysis of archival bankruptcy data to show that discharges actually occurred. Not only did bankrupts benefit when creditors chose to discharge bankrupts prior to full payment, but also we find that creditors could benefit due to greater asset revelation by bankrupts.
---------------------
Corporate governance and performance of financial institutions
Andrey Zagorchev & Lei Gao
Journal of Economics and Business, forthcoming
Abstract:
We examine how corporate governance affects financial institutions in the U.S. between 2002 and 2009. First, we find that better governance is negatively related to excessive risk-taking and positively related to the performance of U.S. financial institutions. Specifically, sound overall and specific governance practices are associated with less total non-performing assets, less real estate non-performing assets, and higher Tobin's Q. Second, we show that better governance contributes to higher provisions and reserves for loan/asset losses of financial institutions, supporting the income smoothing hypothesis. Moreover, the results are similar without the financial crisis period, and different robustness checks confirm the analysis.
---------------------
Shareholders’ preference for excessively risky projects, equilibrium debt contracts, and bailouts
Michael Smith
Journal of Accounting and Public Policy, May–June 2015, Pages 244–266
Abstract:
I show that bailouts can reduce excessive risk-taking. After receiving debt financing, a limited-liability firm chooses between two projects. The safe project results in higher expected cash flows. The excessively risky project results in lower expected debt repayments because default occurs more often. In equilibrium, the creditor anticipates the risk choice of the firm and sets the debt repayment to obtain its required rate of return. The implicit bailout subsidy allows the creditor to lower the debt service payment. As a result, the incremental default benefit of the risky project is lower, leading to less risk-taking. The results inform the ongoing debate about the determinants of risk-taking by firms.
---------------------
CMBS and Conflicts of Interest: Evidence from a Natural Experiment on Servicer Ownership
Maisy Wong
University of Pennsylvania Working Paper, May 2015
Abstract:
I study a natural experiment in commercial mortgage-backed securities (CMBS) where some special servicers changed owners (treatment group) from 2009-2010 but not others (placebo group). The ownership change linked sellers (special servicers who liquidate CMBS assets on behalf of bondholders) and buyers (new owners), presenting a classic self-dealing conflict. Average loss rates for liquidations are 11 percentage points higher (implying additional losses of $3.2 billion for bondholders) after treated special servicers changed owners, but not for the placebo group. I provide the first direct measure of self-dealing that links buyers and sellers in securities markets in the United States.