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Abstract:
In this paper, we provide an overview of the subprime mortgage securitization process and the seven key informational frictions that arise. We discuss the ways that market participants work to minimize these frictions and speculate on how this process broke down. We continue with a complete picture of the subprime borrower and the subprime loan, discussing both predatory borrowing and predatory lending. We present the key structural features of a typical subprime securitization, document how rating agencies assign credit ratings to mortgage-backed securities, and outline how these agencies monitor the performance of mortgage pools over time. Throughout the paper, we draw upon the example of a mortgage pool securitized by New Century Financial during 2006.

subprime mortgage credit, securitization, rating agencies, principal agent, moral hazard

Abstract:
Many have claimed that credit default swaps (CDSs) have lowered the cost of debt financing to firms by creating new hedging opportunities and information for investors. This paper evaluates the impact that the onset of CDS trading has on the spreads that underlying firms pay to raise funding in the corporate bond and syndicated loan markets. Employing a range of methodologies, we fail to find evidence that the onset of CDS trading lowers the cost of debt financing for the average borrower. Further, we uncover economically significant adverse effects on risky and informationally opaque firms.

Credit default swaps, loan spreads, credit spreads

Abstract:
Many have claimed that credit default swaps (CDSs) have lowered the cost of debt financing to firms by creating new hedging opportunities and information for investors. This paper evaluates the impact that the onset of CDS trading has on the spreads that underlying firms pay to raise funding in the corporate bond and syndicated loan markets. Employing a range of methodologies, we fail to find evidence that the onset of CDS trading lowers the cost of debt financing for the average borrower. Further, we uncover economically significant adverse effects on risky and informationally opaque firms.

Credit default swaps, loan spreads, credit spreads.

Abstract:
I present evidence that the cross-guarantee authority granted to the FDIC by the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 has unexpectedly strengthened the Federal Reserve's source-of-strength doctrine. In particular, I find that a bank affiliated with a multi-bank holding company is significantly safer than either a stand-alone bank or a bank affiliated with a one-bank holding company. Not only does affiliation reduce the probability of future financial distress, but distressed affiliated banks are more likely to receive capital injections and recover more quickly than other banks. Moreover, the effects of affiliation are strengthened for an expanding bank holding company. However, the effects of affiliation are weakened when the parent has less than full ownership of the subsidiary. Most interestingly, my results show that these differences in behavior across affiliation did not exist before 1989, when the cross-guarantee authority was introduced.

cross-guarantee provision, source-of-strength doctrine, bank capital regulation

Abstract:
Exploring the functioning of internal capital markets in financial conglomerates, this paper conducts a novel test of the credit channel of monetary policy. We look at differences in the response of lending to monetary policy shocks across small banks that are affiliated with the same bank holding company but that operate in different geographical areas. These banks tap into the same pool of funds but face different pools of borrowers. Because small subsidiary banks concentrate their lending with small local businesses (whose fortunes are tied to their local economies), we can exploit cross-sectional differences in local economic conditions at the time of a monetary policy shock to study whether the strength of borrowers' balance sheets influences the response of bank lending to policy. We find evidence that the negative response of bank loan growth to a monetary contraction is significantly more (less) pronounced when borrowers are more likely to have weak (strong) balance sheets. On the flip side, borrowers with weak balance sheets obtain more new bank credit than other borrowers in monetary expansions. Our results are consistent with the operation of a demand-driven transmission mechanism that works independently of the bank-supply (lending) channel. In fact, our estimates suggest that borrowers' balance sheet strength accounts for a significant fraction of the broad credit channel of monetary policy.

Firm Financial Constraints, Monetary Policy, Balance Sheet Channel, Financial Conglomerates, Internal Capital Markets

Abstract:
In contrast to existing research, I find that tougher capital requirements were probably not responsible for the increase in capital ratios throughout the 1980s. Banks with low capital ratios tended to mean-revert well before any change in policy, and did not raise their capital ratios any faster after the policy change relative to better-capitalized banks. These conclusions are unchanged when exploiting a natural experiment - the plausibly exogenous elimination of differences across Federal Reserve System membership status in leverage requirements for community banks in 1985. I argue that these results are consistent with the presence of market-based incentives for banks to hold capital so that existing regulatory capital requirements were not binding.

Bank capital requirements, moral hazard, bank regulation

Abstract:
The FDIC used cross-guarantees in order to close 38 subsidiaries of First Republic Bank Corporation in 1988 and 18 subsidiaries of First City Bank Corporation in 1992 when lead banks from each of these Texas-based bank holding companies were declared insolvent. I use this plausibly exogenous failure of otherwise healthy subsidiary banks as a natural experiment in order to study the impact of bank failure on local area real economic activity. The resolution of these institutions was associated with a significant decline in failed bank lending that led to a permanent reduction in real county income of about 3 percent.

Bank failures, cross-guarantee, uniqueness of banks

Abstract:
Do banks play a special role in the transmission mechanism of monetary policy? I exploit the presence of internal capital markets in bank holding companies to isolate plausibly exogenous variation in the financial constraints faced by banks. I demonstrate that affiliated bank loan growth is less sensitive to changes in the federal funds rate and that affiliated banks are better able to smooth insured deposit outflows by issuing uninsured debt. Financial constraints matter for equilibrium lending as state loan growth also becomes less sensitive to changes in the federal funds rate as loan market share of affiliated banks increases, but do not seem to matter for equilibrium real variables, as state output growth is largely unaffected.

internal capital markets, lending channel

Abstract:
Although bank capital regulation permits a bank to choose freely between equity and subordinated debt to meet capital requirements, lenders and investors view debt and equity as imperfect substitutes. It follows that the mix of debt in regulatory capital should isolate the role that the market plays in disciplining banks. I document that since the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA) reduced the ability of the FDIC to absorb losses of subordinated debt investors, the mix of debt has had a positive effect on the future outcomes of distressed banks, as if the presence of debt investors has worked to limit moral hazard. To mitigate concerns about selection, I use the variation across banks in the mix of debt in capital generated by cross-state variation in state corporate income tax rates. Interestingly, instrumental variables (IV) estimates document that selection problems are indeed important, but suggest that the benefits of subordinated debt are even larger. I conclude that the market may play a useful direct role in regulating banks.

market discipline, subordinated debt, bank capital regulation, financial distress, bond covenants

Abstract:
Thousands of U.S. households filed for bankruptcy just before the bankruptcy law changed in 2005. That rush-to-file was more pronounced, we find, in states with more generous bankruptcy exemptions and lower credit scores. We take that finding as evidence that the new law effectively reduces exemptions, which in turn should reduce the "demand" for bankruptcy and the resulting losses to suppliers of consumer credit. We expect the savings to suppliers will be shared with borrowers by way of lower credit card rates, although credit card spreads have not yet fallen. If cheaper credit is the upside of the new law, the downside is reduced bankruptcy "insurance" against bad luck. The overall impact of the new law on the average household depends on how one weighs those two sides.

bankruptcy, consumption smoothing, insurance, moral hazard

Abstract:
Using plausibly exogenous variation in demand for federal funds created by daily shocks to reserve balances, we identify the supply curve facing a bank borrower in the inter-bank market, and study how access to overnight credit is affected by changes in public and private measures of borrower creditworthiness. While there is evidence that lenders respond to adverse changes in public information about credit quality by restricting access to the market in a fashion consistent with market discipline, there is also evidence that borrowers are able to respond to adverse changes in private information about credit quality by increasing leverage as if to offset the future impact on earnings. While the responsiveness of investors to public information is comforting, we document evidence which suggests that banks are able to manage the real information content of these disclosures. In particular, public measures of loan portfolio performance have information about future loan chargeoffs, but only in quarters when the bank is examined by supervisors. However, the loan supply curve is not any more sensitive to public disclosures about nonperforming loans in an exam quarter, suggesting that investors are unaware of this information management.

Earnings management, market discipline, opaqueness

Abstract:
The Federal Home Loan Bank (FHLB) System is a large, complex, and understudied government-sponsored liquidity facility that currently has more than $1 trillion in secured loans outstanding, mostly to commercial banks and thrifts. In this paper, we document the significant role played by the FHLB System at the onset of the ongoing financial crises and then provide evidence on the uses of these funds by the System's bank and thrift members. Next, we identify the trade-offs faced by member-borrowers when choosing between accessing the FHLB System or the Federal Reserve's Discount Window during the crisis period. We conclude by describing the fragmented U.S. lender-of-last-resort framework and finding that additional clarity about the respective roles of the various liquidity facilities would be helpful.

Federal Home Loan Bank, government-sponsored enterprise, lender of last resort, liquidity

Abstract:
Building on recent evidence concerning the functioning of internal capital markets in financial conglomerates, we conduct a novel test of the balance-sheet channel of monetary policy. Specifically, we investigate how the response of lending to monetary policy differs across small banks that are affiliated with the same bank holding company but operate in different geographical areas. These banks face similar constraints in accessing internal and external sources of funds, but have different pools of borrowers. Because they typically concentrate their lending with small local businesses, we can exploit cross-sectional differences in local economic indicators at the time of a policy shock to study whether the strength of borrowers' balance sheets affects the response of bank lending. We find evidence that the negative response of bank loan growth to a monetary contraction is significantly stronger when borrowers have weaker balance sheets.

balance sheet channel, internal capital markets

Abstract:
Liquidity hoarding by banks and extreme volatility of the fed funds rate have been widely seen as severely disrupting the interbank market and the broader financial system during the 2007-08 financial crisis. Using a dataset of intraday Federal Reserve bank account balances and Fedwire interbank transactions to estimate all overnight fed funds trades, we show empirical evidence on banks' precautionary hoarding of reserves, reluctance to lend and extreme fed funds rate volatility. We develop a model with credit and liquidity frictions in the interbank market consistent with the empirical results. Banks rationally hold excess reserves intraday and overnight as a precautionary measure to self-insure against liquidity shocks. The intraday fed funds can spike above the discount rate and crash to near zero. Apparent anomalies during the crisis may be explained as the stark but natural outcomes of our general model of the interbank market. The model also provides a unified explanation for previously documented stylized facts and makes new predictions for the interbank market.

excess reserves, fed funds market, discount window, large-value payments, limited participation

Abstract:
Using miscarriage as an instrument for birth suffers from a
censoring problem created by the fact that women wanting the
pregnancy to end in an abortion frequently pre-empt an
"assigned" miscarriage. I describe evidence that this problem
is severe, creates a significant bias in IV estimates, and
develop non-parametric estimators to correct for censoring.
While simple IV estimates previously suggested teenage
childbearing had little effect on high school completion or
labor market outcomes later in life, non-parametric IV
estimates indicate significant costs of teenage childbearing,
particularly for high school aged girls.

Abstract:
Monetary policy is a blunt instrument with which to smooth aggregate volatility. I demonstrate that there is actually very little correlation between how much real state income responds to monetary policy and to shocks that prompt aggregate smoothing by the Federal Reserve. This mismatch turns out to be strong enough to imply that while monetary policy might have reduced the variance of aggregate output in the US over the last three decades, it has actually increased the variance of output in a majority of states. Moreover, policy rules that minimize aggregate variance are not equal in the severity of distortions they create in the volatility of state income. Optimal rules that place more weight on price variance typically create the largest distortions while those that place weight on aggregate income volatility create the smallest. In the end, monetary policy has the potential to create large distortions, but need not do so.

monetary policy, aggregate smoothing

Abstract:
Liquidity hoarding by banks and extreme volatility of the fed funds rate have been widely seen as severely disrupting the interbank market and the broader financial system during the 2007-08 financial crisis. Using data on intraday account balances held by banks at the Federal Reserve and Fedwire interbank transactions to estimate all overnight fed funds trades, we present empirical evidence on banks’ precautionary hoarding of reserves, their reluctance to lend, and extreme fed funds rate volatility. We develop a model with credit and liquidity frictions in the interbank market consistent with the empirical results. Our theoretical results show that banks rationally hold excess reserves intraday and overnight as a precautionary measure against liquidity shocks. Moreover, the intraday fed funds rate can spike above the discount rate and crash to near zero. Apparent anomalies during the financial crisis may be seen as stark but natural outcomes of our model of the interbank market. The model also provides a unified explanation for several stylized facts and makes new predictions for the interbank market.

Tax law, S corporations, organizational form, dividend policy, sell-offs, industry structure

Abstract:
We examine the effect of teenage childbearing on the adult outcomes of a sample of women who gave birth, miscarried or had an abortion as teenagers. If miscarriages are (conditionally) random, then if all miscarriages occur before teenagers can obtain abortions, using the absence of a miscarriage as an instrument for a live birth provides a consistent estimate of the effect of teenage motherhood on women who give birth. If all abortions occur before any miscarriage can occur, OLS on the sample of women who either have a live birth or miscarry provides an unbiased estimate of this effect. Under reasonable assumptions, IV underestimates and OLS overestimates the effect of teenage motherhood on adult outcomes. For a variety of outcomes, the two estimates provide a narrow bound on the effect of teenage motherhood on adult outcomes and which is relatively modest. The bounds can also be combined to provide consistent estimates of the effects of teen motherhood. These effects are generally adverse but modest.

Abstract:
In the second half of 2008, the issuance of auto, credit card, and student loan asset-backed securities (ABS) all but stopped while secondary market spreads on AAA-rated tranches of consumer ABS reached historical levels. If sustained, the break-down of the originate-to-distribute model for consumer credit would force banks which made new loans to retain them on their balance sheets, increasing demands on liquidity and capital, and threatened to amplify the impact of a housing recession through a consumer credit crunch. In response to these conditions, the Federal Reserve and US Treasury announced in November 2008 the Term Asset-backed securities Liquidity Facility (TALF). In order to promote lending to consumers and small businesses, the facility provides up to $200 billion in three-year non-recourse loans to investors in the AAA-rated tranches of new issue consumer ABS as well as pools secured by SBA loans. Given the positive reaction of the market to the announcement of the facility, the Administration recently announced an expansion of the TALF to include additional asset classes, including but not limited to new issue ABS secured by the following asset classes: commercial and residential real estate; equipment loans, leases, and floorplan; rental fleet lease; and servicer advances. In the paper, the authors will not only document the bottlenecks in each of the markets targeted by the TALF, but will also document the impact of the facility on ABS issuance starting with the first funding in late March 2009. Finally, the authors outline various exit strategies of the public sector, and speculate on how securitization should work in the future.

Abstract:
There is strong evidence that the interest rates charged by banks on the flow of newly extended Commercial & Industrial (C&I) loans predict future loan performance and CAMEL rating downgrades by bank supervisors. While internal risk ratings have little explanatory power for future loan performance, they do help predict future CAMEL downgrades. These findings suggest that supervisors might consider using interest rates in the off-site surveillance of banks. At the same time, we propose that reformers consider basing capital requirements and deposit insurance premia on loan interest rates instead of (or in addition to) internal risk ratings and models.

Deposit insurance reform, credit risk pricing, risk-based capital regulation