Knowledge that Transforms

This paper examines whether securitization has an ex-post effect on residential loan renegotiation. It makes two main contributions to the existing literature. First, this paper evaluates the re-default and self-cure rates of loans using bank-reported loan renegotiation data. Second, it conducts a transition probability study to better understand the re-default and self-cure dynamics by time and previous loan state. I find that previously delinquent portfolio loans are less likely to re-default and more likely to self-cure than comparable securitized loans during the intermediate time frame, but the difference diminishes afterwards. For previously cured loans, portfolio loans and securitized loans have generally similar re-default and self-cure rates over time. This paper emphasizes that it is important to understand the dynamic transition behavior of mortgage loans.

We present a model of an economy with heterogeneous banks that may be funded with uninsured deposits and equity capital. Capital serves to ameliorate a moral hazard problem in the choice of risk. There is a fixed aggregate supply of bank capital, so the cost of capital is endogenous. A regulator sets risk-sensitive capital requirements in order to maximize a social welfare function that incorporates a social cost of bank failure. We consider the effect of a negative shock to the supply of bank capital and show that optimal capital requirements should be lowered. Failure to do so would keep banks safer but produce a large reduction in aggregate investment. The result provides a rationale for the cyclical adjustment of risk-sensitive capital requirements.

This paper examines the impact of bank capital ratios on bank lending by comparing differences in loan growth to differences in capital ratios at sets of banks that are matched based on geographic area as well as size and various business characteristics. We argue that such comparisons are most effective at controlling for local loan demand and other environmental factors. For comparison we also control for local factors using MSA fixed effects. We find, based on data from 2001 to 2011, that the relationship between capital ratios and bank lending was significant during and shortly following the recent financial crisis but not at other times. We find that the relationship between capital ratios and loan growth is stronger for banks where loans are contracting than where loans are expanding. We also show that the elasticity of bank lending with respect to capital ratios is higher when capital ratios are relatively low, suggesting that the effect of capital ratio on bank lending is nonlinear. In addition, we present findings on the relationship between bank capital and lending by bank size and loan type.

This paper studies banks’ incentives to engage in liquidity cross-insurance. In contrast to previous literature we view interbank insurance as the outcome of bilateral (and non-exclusive) contracting between pairs of banks and ask whether this outcome is socially efficient. Using a simple model of interbank insurance we find that this is indeed the case when insurance takes place through pure transfers. This is even though liquidity support among banks sometimes breaks down, as observed in the crisis of 2007–2008. However, when insurance is provided against some form of repayment (such as is the case, for example, with credit lines), banks have a tendency to insure each other less than the socially efficient amount. We show that efficiency can be restored by introducing seniority clauses for interbank claims or through subsidies that resemble government interbank lending guarantees.

This paper documents large cross-country variation in the relationship between bank competition and bank stability and explores market, regulatory and institutional features that can explain this variation. We show that an increase in competition will have a larger impact on banks’ fragility in countries with stricter activity restrictions, lower systemic fragility, better developed stock exchanges, more generous deposit insurance and more effective systems of credit information sharing. The effects are economically large and thus have important repercussions for the current regulatory reform debate.

The high levels of operating efficiency, profits, and market values for banks in the years before the financial crisis raise reasonable doubts about the accuracy of the assessments of the efficiency of banking intermediation. We examine the productivity growth in Spanish banks in the pre-crisis period by separating out the contributions to productivity growth from business practices and from industry-wide technological progress. We find that more than two thirds of the estimated productivity growth in the years 2000–2007 is attributed to banks’ practices, such as the expansion of credit in the housing market, the high recourse to securitization and short-term finance, the reduction in liquidity holdings, and the leveraging process of banks’ balance sheets, that the literature claims are the ultimate causes of the crisis. We estimate that the remaining cumulative annual growth rate is 2.8% for the industry’s technical progress, which is similar to that in the period of 1992–2000.

The contingent claims analysis of firm financing often presents a debt renegotiation game with a passive bank that does not use its ability to force liquidation strategically, contrary to what is observed in practice. We consider two motives that may lead a bank to refuse to renegotiate: maintaining its reputation to preserve its future lending activity and deterring firms from overstating their debt service abatement when they renegotiate. We show that with public information and private debt only, the optimal probability of debt renegotiation is high when the firm’s anticipated liquidation value is high. Under asymmetric information about liquidation value, the high liquidation value firm may be tempted to mimic the low liquidation value firm to reduce its debt service. To deter such mimicking, banks may sometimes refuse to renegotiate with firms having a low liquidation value.

This study empirically examines the value added for investors during the 2007–2009 financial crisis from hedge fund-like equity mutual funds, including 130/30, market neutral, and long/short equity funds. We find that based on the information ratio, all market neutral funds, top 90% of long/short funds, and top 25% of 130/30 funds outperform a long-only passive index fund over the crisis period. However, we find little evidence of abnormal performance by the average and median funds in our sample, based on either unconditional or conditional four-factor alphas. The reason for the overall under-performance in the crisis period is that while short positions taken by these funds do generate alpha, the gain from their short positions is not sufficiently large to offset the loss from their long positions. Finally, the abnormal performance of short positions is found to be attributable to managers’ characteristic-adjusted and industry-adjusted stock selection skills. One implication of this study is that even though market neutral and long/short funds on average may not generate alpha, investors can benefit from holding these funds, especially the former, that can provide a hedge against down markets due to their low betas and that can be useful for asset allocation.

We measure the effect of bank failures on economic growth using data from 1900 to 1930, a period without active government stabilization policies and several severe banking crises. VAR model estimates suggest bank failures have long-lasting negative effects on economic growth. A bank failure shock involving one percent of system liabilities leads to a 6.5% reduction in GNP growth within three quarters and a measurable reduction for 10 quarters. Panel VAR model estimates for the 48 states show bank failures aggravate commercial non-bank failures. Institutional and regulatory features affect the intensity of the bank failure effect. We find that bank failures have a larger impact in states with deposit insurance, in states more heavily concentrated in agriculture, and in states with fewer large firms. However, because a number of states exhibit all three characteristics, we are not able to clearly identify the true marginal effects of these factors independently.

I study how often and why a serial founder receives financing for his new company from a venture capital (VC) firm that also invested in his previous company. One in 10 VC investments leads to a repeated relationship and one in three serial founders enters into a repeated relationship with any previous VC firm. A repeated relationship is more likely when the relational VC firm has acquired more private information about the founder, but less likely if the founder’s new venture has a bad fit with the VC firm’s geographic or industry focus. My findings add to the literature on relational financing by showing that the preservation of information is an important motivation for relational financing when screening and monitoring costs are high. Yet, repeated relationships are discontinued because investors also respond to information problems by specializing in certain types of firms. Finally, I find evidence of non-relational investments being passed onto trusted VC syndication partners.