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Abstract:
We demonstrate that a rapid expansion in the supply of mortgages driven by disintermediation explains a large fraction of recent U.S. house price appreciation and subsequent mortgage defaults. We identify the effect of shifts in the supply of mortgage credit by exploiting within-county variation across zip codes that differed in latent demand for mortgages in the mid 1990s. From 2001 to 2005, high latent demand zip codes experienced large relative decreases in denial rates, increases in mortgages originated, and increases in house price appreciation, despite the fact that these zip codes experienced significantly negative relative income and employment growth over this time period. These patterns for high latent demand zip codes were driven by a sharp relative increase in the fraction of loans sold by originators shortly after origination, a process which we refer to as "disintermediation." The increase in disintermediation-driven mortgage supply to high latent demand zip codes from 2001 to 2005 led to subsequent large increases in mortgage defaults from 2005 to 2007. Our results suggest that moral hazard on behalf of originators selling mortgages is a main culprit for the U.S. mortgage default crisis.

Abstract:
We conduct a within-county analysis using detailed zip code level data to document new findings regarding the origins of the biggest financial crisis since the Great Depression. The recent sharp increase in mortgage defaults is significantly amplified in subprime zip codes, or zip codes with a disproportionately large share of subprime borrowers as of 1996. Prior to the default crisis, these subprime zip codes experience an unprecedented relative growth in mortgage credit. The expansion in mortgage credit from 2002 to 2005 to subprime zip codes occurs despite sharply declining relative (and in some cases absolute) income growth in these neighborhoods. In fact, 2002 to 2005 is the only period in the last eighteen years when income and mortgage credit growth are negatively correlated. We show that the expansion in mortgage credit to subprime zip codes and its dissociation from income growth is closely correlated with the increase in securitization of subprime mortgages. Finally, we show that all of our key findings hold in markets with very elastic housing supply that have low house price growth during the credit expansion years.

subprime, sub-prime, mortgages, default crisis, disintermediation, defaults, consumer credit, credit supply, credit expansion

Abstract:
Using individual-level data on homeowner debt and defaults from 1997 to 2008, we show that borrowing against the increase in home equity by existing homeowners is responsible for a significant fraction of both the sharp rise in U.S. household leverage from 2002 to 2006 and the increase in defaults from 2006 to 2008. Employing land topology-based housing supply elasticity as an instrument for house price growth, we estimate that the average homeowner extracts 25 to 30 cents for every dollar increase in home equity. Money extracted from increased home equity is not used to purchase new real estate or pay down high credit card debt, which suggests that real outlays (i.e., consumption or home improvement) are likely uses of borrowed funds. Home equity-based borrowing is stronger for younger households, households with low credit scores, and households with high initial credit card utilization rates. Homeowners in high house price appreciation areas experience a relative decline in default rates from 2002 to 2006 as they borrow heavily against their home equity, but experience very high default rates from 2006 to 2008. Our estimates suggest that home equity-based borrowing is equal to 2.8% of GDP every year from 2002 to 2006, and accounts for 34% of new defaults from 2006 to 2008.

subprime, mortgage, home equity, household leverage, house prices, consumption, wealth effect

Abstract:
We examine the effects of constituent interests, special interests, and politician ideology on congressional voting behavior on two of the most significant pieces of legislation in U.S. economic history: the American Housing Rescue and Foreclosure Prevention Act of 2008 and the Emergency Economic Stabilization Act of 2008. Representatives from districts experiencing an increase in mortgage default rates are more likely to vote in favor of the AHRFPA, and the response is stronger in more competitive districts. Representatives only respond to mortgage related defaults (not non-mortgage defaults), and are more sensitive to defaults of their own-party constituents. Higher campaign contributions from the financial services industry are associated with an increased likelihood of voting in favor of the EESA, a bill which transfers wealth from tax payers to the financial services industry. Examining the trade-off between ideology and economic incentives, we find that conservative politicians are less responsive to both constituent and special interests. This latter finding suggests that politicians, through ideology, can commit against intervention even during severe crises.

Abstract:
We show that household leverage is an early and powerful predictor of the 2007 to 2009 recession. Counties in the U.S. that experienced a large increase in household leverage from 2002 to 2006 showed a sharp relative decline in durable consumption starting in the third quarter of 2006 – a full year before any significant change in unemployment. Similarly, counties with the highest reliance on credit card borrowing reduced durable consumption by significantly more following the financial crisis of the fall of 2008. Overall, our estimates show that household leverage growth and dependence on credit card borrowing explain a large fraction of the overall consumer default, house price, unemployment, residential investment, and durable consumption patterns during the recession. Our findings suggest that a focus on household finance may help elucidate the sources macroeconomic fluctuations.

household finance, economic fluctuations, recession, household leverage, housing crisis, mortgage defaults, unemployment, auto sales, durable consumption, residential investment

Abstract:
Corruption by the politically connected is often blamed for economic ills, particularly in less developed economies. Using a loan-level data set of more than 90,000 firms that represents the universe of corporate lending in Pakistan between 1996 and 2002, we investigate rents to politically connected firms in banking. Classifying a firm as political if its director participates in an election, we examine the extent, nature, and economic costs of political rent provision. We find that political firms borrow twice as much and have 50% higher default rates. Such preferential treatment occurs exclusively in government banks - private banks provide no political favors. Using firm fixed effects and exploiting variation across time or lenders, we show that the observed political preference is driven by the political status of the firm and not by any unobserved firm characteristic. The political rents thus identified increase with the strength of the firm's politician and whether he or his party is in power, and fall with the degree of electoral participation in his constituency. We provide direct evidence that rules out alternative explanations such as socially motivated lending by government banks to politicians. The economy wide costs of the rents identified are estimated to be 0.3% to 1.9% of GDP every year.

Abstract:
The partition of India in 1947 along ostensibly religious lines into India, Pakistan, and what eventually became Bangladesh resulted in one of the largest and most rapid migrations in human history. We compile district level census data from archives to quantify the scale of migratory flows across the sub-continent. We estimate total migratory inflows of 14.5 million and outflows of 17.9 million, implying 3.4 million "missing" people. We also uncover a substantial degree of regional variability. Flows were much larger along the western border, higher in cities and areas close to the border, and dependent heavily on the size of the "minority" religious group. The migratory flows also display a "relative replacement effect" with in-migrants moving to places that saw greater out-migration.

Abstract:
We show that institutions that promotional development ease borrowing constraints by lowering the collateral spread, and shifting the composition of acceptable collateral towards firm-specific assets. Using a novel cross-country loan-level data set, we estimate collateral spread as the difference in rates of collateralization between high and low risk borrowers in a given economy. The average collateral spread is large but declines rapidly with financial development. A one standard deviation improvement in financial development due to stronger institutions leads to a reduction in collateral spread by one-half. We also find that the composition of collateralizable assets shifts towards non-specific assets (e.g. land) with increased risk. However, this shift is considerably smaller in more developed financial markets, thus enabling risky borrowers to use a larger variety of assets as collateral.

collateral, financial development, banks, emerging markets

Abstract:
How far can institutional mobility of multi-national banks address the financial development concerns of poor economies? Using a new quarterly panel data set of 80,000 loans over 7 years, I show that greater cultural and geographical distance between a foreign bank's head quarter and the local branches, leads it to further avoid lending to informationally difficult yet fundamentally sound firms requiring relational contracting. Greater distance also makes them less likely to bilaterally renegotiate, and less successful at recovering defaults. Differences in bank size, legal institutions, risk preferences, or unobserved borrower heterogeneity cannot explain these results. The distance constraints identified in this paper can be economically large enough to permanently exclude certain sectors of the economy from financing by foreign banks.

Abstract:
Large scale migrations, especially involuntary ones, can have a substantial impact on the demographics of both sending and receiving communities. We estimate the impact of the 1947 Indian subcontinent partition, one of the largest and most rapid population exchanges in human history. Comparing neighboring districts better isolates the effect of the migratory flows from secular changes. We find large effects on a districts' educational, occupational, and gender composition within four years. Due to higher education levels amongst migrants, districts with greater inflows saw their literacy rates increase by 16% more while outflows reduced literacy rates by as much as 20%. With less land vacated by those who left Indian Punjab, Indian districts with large inflows saw a decline of 70% in the growth of agricultural occupations. Affected districts also experienced large changes in gender composition with a relatively large drop in percentage men in Indian districts that experienced large outflows, and in Pakistani districts with large inflows. While the partition, driven along religious lines, increased religious homogenization within communities, our results suggest that this was accompanied by increased educational and occupational differences within religious groups. We hypothesize that these compositional effects, in addition to an aggregate population impact, are likely features of involuntary migrations and, as in the case of India, Pakistan, and Bangladesh, can have important long-term consequences.

Abstract:
We examine the impact of liquidity shocks by exploiting cross-bank liquidity variation induced by unanticipated nuclear tests in Pakistan. We show that for the same firm borrowing from two different banks, its loan from the bank experiencing a 1% larger decline in liquidity drops by an additional 0.6%. While banks pass their liquidity shocks on to firms, large firms - particularly those with strong business or political ties - completely compensate this loss by additional borrowing through the credit market. Small firms are unable to do so and face large drops in overall borrowing and increased financial distress.

Abstract:
Do liquidity shocks matter? While even a simple `yes` or `no` presents identification challenges, going beyond this entails tracing how such shocks to lenders are passed on to borrowers, and whether borrowers can in turn cushion these shocks through the credit market. This paper does so by using data that follows all loans made by lenders to borrowing firms in Pakistan, and exploiting cross-bank variation in liquidity shocks induced by the unanticipated nuclear tests in 1998. We isolate the causal impact of the bank lending channel by showing that for the same firm borrowing from two different banks, its loan from the bank experiencing a 1% larger decline in liquidity drops by an additional 0.6%. The liquidity shock also lowers the probability of continued lending to old clients and extending credit to new ones. Although this lending channel affects all firms significantly, large firms and those with strong business and political ties completely compensate the effect by borrowing more from more liquid banks - both through existing and new banking relationships. In contrast, small unconnected firms are entirely unable to hedge and face large drops in overall borrowing and increased financial distress. The liquidity shocks thus have large distributional consequences.

Abstract:
We examine the determinants of congressional voting behavior on two of the most significant pieces of federal legislation in U.S. economic history: the American Housing Rescue and Foreclosure Prevention Act of 2008 and the Emergency Economic Stabilization Act of 2008. We find evidence that constituent interests and special interests influence voting patterns during the crisis. Representatives from districts experiencing an increase in mortgage default rates are significantly more likely to vote in favor of the AHRFPA. They are precise in responding only to mortgage related constituent defaults, and are significantly more sensitive to defaults of their own-party constituents. Increased campaign contributions from the financial services industry is associated with a higher likelihood of voting in favor of the EESA, a bill which transfers wealth from tax payers to the financial services industry. We also examine the trade-off between politician ideology and constituent and special interests, and find that conservative politicians are less responsive to constituent and special interest pressure. This latter finding suggests that politicians, through ideology, can commit against intervention even during severe crises.

Abstract:
Most government expenditure is on goods that yield primarily private benefits, such as education, pensions, and healthcare. We argue that markets are most advantageous in areas where high-powered incentives are desirable, but in areas where high-powered incentives stimulate unproductive signalling effort, firms, or even government, may have a comparative advantage. Firms may be able to weaken incentives and improve efficiency by obscuring information about individual workers' contribution to output, and thus reducing their willingness to signal through a moral-hazard-in-teams reasoning. However, firms themselves may be unable to commit to not providing greater compensation to employees who distort their efforts to improve observed performance. Government organizations, on the other hand, often have to flatter wage schedules, thereby naturally weakening the power of incentives. We suggest that there are also endogenous reasons for why governments, even when they are run by self-interested politicians, may be able to commit to lower powered incentives than firms, because government operation makes yardstick comparisons, which increase the power of incentives, more difficult

Abstract:
Using individual-level data on homeowner debt and defaults from 1997 to 2008, we show that borrowing against the increase in home equity by existing homeowners is responsible for a significant fraction of both the sharp rise in U.S. household leverage from 2002 to 2006 and the increase in defaults from 2006 to 2008. Employing land topology-based housing supply elasticity as an instrument for house price growth, we estimate that the average homeowner extracts 25 to 30 cents for every dollar increase in home equity. Money extracted from increased home equity is not used to purchase new real estate or pay down high credit card balances, which suggests that borrowed funds may be used for real outlays (i.e., consumption or home improvement). Home equity-based borrowing is stronger for younger households, households with low credit scores, and households with high initial credit card utilization rates. Homeowners in high house price appreciation areas experience a relative decline in default rates from 2002 to 2006 as they borrow heavily against their home equity, but experience very high default rates from 2006 to 2008. Our estimates suggest that home equity-based borrowing is equal to 2.8% of GDP every year from 2002 to 2006, and accounts for at least 34% of new defaults from 2006 to 2008.

Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.

Abstract:
Theory suggests that greater hierarchical distance between a subordinate and his boss makes it more difficult to share abstract and subjective information in decision making. A novel dataset put together from credit dossiers of large corporate loan applicants enables us to observe the information collected by loan officers, and how it is used by the ultimate loan approving officer. We find that greater hierarchical/geographical distance between the information collecting agent and the loan approving officer leads to less reliance on subjective information and more on objective information. By exploiting nonlinearities in the “assignment rules” that determine an applicant's hierarchical distance, and using information collecting agent fixed effects, we show that our result cannot be driven by endogenous assignment of applicants. We also find that higher frequency of interactions between the information collecting agent and loan approving officer, both over time and through geographical proximity, helps mitigate the effects of hierarchical distance on information use. Our results show that hierarchical distance influences information use, and highlights the importance of “human touch” in communication.

D21, D83, G21, G30

Abstract:
Theory suggests that greater hierarchical distance between a subordinate and his boss makes it more difficult to share abstract and subjective information in decision making. A novel data set put together from credit dossiers of large corporate loan applicants enables us to observe the information collected by loan officers and also how it is used by the ultimate loan approving officer. We find that greater hierarchical / geographical distance between the information collecting agent and the loan approving officer leads to less reliance on subjective information and more on objective information. By exploiting non-linearities in the "assignment rules" that determine an applicant's hierarchical distance, and using information collecting agent fixed effects, we show that our result cannot be driven by endogenous assignment of applicants. We also find that higher frequency of interactions between the information collecting agent and loan approving officer, both over time and through geographical proximity, helps mitigate the effects of hierarchical distance on information use. Our results show that hierarchical distance influences information use, and highlight the importance of "human touch" in communication.

Abstract:
We construct a simple career concerns model where high-powered incentives can distort the composition of effort by inducing excessive signaling. We show that in the presence of this type of career concerns, markets typically fail to limit competitive pressures and cannot commit to the desirable low-powered incentives. Firms may be able to weaken incentives and improve efficiency by obscuring information about individual workers' contribution to output, and thus reducing their willingness to signal through a moral-hazard-in-teams reasoning. However, firms themselves have a commitment problem, since firm owners would like to provide high-powered incentives to their employees to increase profits. When firms cannot refrain from doing so, government provision may be useful as a credible commitment to low-powered incentives. Governments may be able to achieve this even when operated by a self-interested politician. Among other reasons, this may happen because of the government's ability to limit yardstick competition and reelection uncertainty. We discuss possible applications of our theory to pervasive government involvement in predominantly private goods such as education and management of pension funds. (JEL D23, L22, H10, H52)

Abstract:
Corruption by the politically connected is often blamed for economic ills, particularly in less developed economies. Using a loan-level data set of more than 90,000 firms that represents the universe of corporate lending in Pakistan between 1996 and 2002, we investigate rents to politically connected firms in banking. Classifying a firm as political if its director participates in an election, we examine the extent, nature, and economic costs of political rent provision. We find that political firms borrow 45 percent more and have 50 percent higher default rates. Such preferential treatment occurs exclusively in government banks - private banks provide no political favors. Using firm fixed effects and exploiting variation for the same firm across lenders or over time allows for cleaner identification of the political preference result. We also find that political rents increase with the strength of the firm's politician and whether he or his party is in power, and fall with the degree of electoral participation in his constituency. We provide direct evidence against alternative explanations such as socially motivated lending by government banks to politicians. The economy-wide costs of the rents identified are estimated to be 0.3 to 1.9 percent of GDP every year.

Abstract:
How costly is the poor governance of market intermediaries? Using unique trade level data from the stock market in Pakistan, we find that when brokers trade on their own behalf, they earn annual rates of return that are 50-90 percentage points higher than those earned by outside investors. Neither market timing nor liquidity provision by brokers can explain this profitability differential. Instead we find compelling evidence for a specific trade-based pump and dump price manipulation scheme: When prices are low, colluding brokers trade amongst themselves to artificially raise prices and attract positive-feedback traders. Once prices have risen, the former exit leaving the latter to suffer the ensuing price fall.

Conservative estimates suggest these manipulation rents can account for almost a half of total broker earnings. These large rents may explain why market reforms are hard to implement and emerging equity markets often remain marginal with few outsiders investing and little capital raised.