Knowledge that Transforms

[We use loan-level data from the New York City metropolitan area to examine the extent to which lenders attempted to prevent foreclosures with concessionary modifications during the Great Depression. We find no principal forgiveness in the sample and only a handful of concessionary mortgage modifications of other types. Far more mortgages terminated through foreclosure than received any sort of concessionary modification. The results indicate that there are significant impediments to renegotiation of residential mortgages beyond securitization. As such, less renegotiation seems unlikely to be a major cost of securitization of residential mortgages.]

[A lesson of the recent financial crisis is that the interbank market is crucial for banks facing uncertainty regarding their liquidity needs. This article studies the efficiency of the interbank market in allocating funds. We show that the central bank should lower the interbank rate when confronted with a crisis that causes a disparity in the liquidity held among banks. This suggests that the traditional tenet prescribing the separation between prudential regulation and monetary policy should be abandoned. We also show that failure to cut interest rates during a crisis erodes financial stability by increasing the risk of bank runs.]

[Bank mergers can increase or decrease loan spreads, depending on whether the increased market power outweighs efficiency gains. Using proprietary loan-level data for U.S. commercial banks, I find that, on average, mergers reduce loan spreads, with the magnitude of the reduction being larger when postmerger cost savings increase. My results suggest that the relation between spreads and the extent of the market overlap between merging banks is nonmonotonic. The market overlap increases cost savings and consequently lowers spreads, but when the overlap is sufficiently large, spreads increase, potentially due to the market-power effect dominating the cost savings. Furthermore, the average reduction in spreads is significant for small businesses.]

[We develop a dynamic model of bank capital structure in an acquisitions context which predicts: (i) total bank value and the bank's equity capital are positively correlated in the cross-section, and (ii) the various components of bank value are also positively cross-sectionally related to bank capital. Our empirical tests provide strong support for these predictions. The results are robust to a variety of alternative explanations—growth prospects, desire to acquire toe-hold positions, desire of capital-starved acquirers to buy capital-rich targets, market timing, pecking order, the effect of banks with binding capital requirements, Too Big To Fail, target profitability, risk, and mechanical effects.]

[We analyze proprietary internal capital allocation data from a large retail banking group consisting of member banks and a headquarters organization. We find that capital allocations from headquarters compensate for deposit shortfalls on the bank level, suggesting that the headquarters offers deposit smoothing to member banks. We then analyze how the distribution of influence within the group relates to capital allocations and lending behavior. More influential banks are allocated more funds from headquarters, and their loan growth is less sensitive to their deposit base. The effects of influence are stronger if banks have a greater demand for deposit smoothing.]

[For funds with high incentives and more opportunities to inflate returns, we find that (i) returns during December are significantly higher than returns during the rest of the year, even after controlling for risk in both the time series and the cross-section; and (ii) this December spike is greater than for funds with lower incentives and fewer opportunities to inflate returns. These results suggest that hedge funds manage their returns upward in an opportunistic fashion in order to earn higher fees. Finally, we find strong evidence that funds inflate December returns by underreporting returns earlier in the year but only weak evidence that funds borrow from January returns in the following year.]

[The empty creditor problem arises when a debtholder has obtained insurance against default but otherwise retains control rights in and outside bankruptcy. We analyze this problem from an ex ante and ex post perspective in a formal model of debt with limited commitment, by comparing contracting outcomes with and without insurance through credit default swaps (CDS). We show that CDS, and the empty creditors they give rise to, have important ex ante commitment benefits: By strengthening creditors' bargaining power, they raise the debtor's pledgeable income and help reduce the incidence of strategic default. However, we also show that lenders will over-insure in equilibrium, giving rise to an inefficiently high incidence of costly bankruptcy. We discuss a number of remedies that have been proposed to overcome the inefficiency resulting from excess insurance.]

[We examine the conflicts of interest and the flow of information between divisions of financial institutions. Using data on analyst recommendations and stockholdings of investment banks advising acquirers in mergers, we find evidence that information from investment banking flows to other divisions of the bank. Specifically, following a merger announcement, changes in a bank's stockholdings of the acquirer are positively associated with changes in recommendations by its analyst. This relationship, however, does not exist before the merger announcement. Additional tests show that the relationship between stockholdings and recommendations following a merger announcement is strongest when conflicts of interest for analysts are likely the smallest.]

[The massive losses that banks incurred with the meltdown of the subprime mortgage market have raised concerns about their ability to continue lending to corporations. We investigate these concerns. We find that firms paid higher loan spreads during the subprime crisis. Importantly, the increase in loan spreads was higher for firms that borrowed from banks that incurred larger losses. These results hold after we control for firm-, bank-, and loan-specific factors, and account for endogeneity of bank losses. These findings, together with our evidence that borrowers took out smaller loans during the crisis when they borrowed from banks that incurred larger losses, lend support to the concerns about bank lending following their subprime losses.]

[This article studies bank failures in twenty-one emerging market countries in the 1990s. By using a competing risk hazard model for bank survival, we show that a government is less likely to take over or close a failing bank if the banking system is weak. This Too-Many-to-Fail effect is robust to controlling for macroeconomic factors, financial crises, the Too-Big-to-Fail effect, domestic financial development, and concerns due to systemic risk and information spillovers. The article also shows that the Too-Many-to-Fail effect is stronger for larger banks and when there is a large government budget deficit.]