Accounting for the Crisis

Abstract:     

Time series evidence on leverage suggests that simple financial ratios may not explain the disparate performance of U.S. banking institutions during the financial crisis. I discuss the cross-section determinants of U.S. commercial bank returns, and find that Tier 1 capital ratios explain nearly 40% of bank returns between 2007 and 2009. Among the large institutions with more than $50 billion in assets though, Tier 1 is not a useful ratio. I instead emphasize the importance of special purpose entities (SPEs) in the larger commercial banks. The disclosure of these off-balance sheet entities has been fragmentary, and I find that the number of subsidiaries in their SEC filings is a good proxy for these exposures. Nearly a third of the large commercial bank returns can be accounted for by this simple indirect indicator of regulatory arbitrage.

Number of Pages in PDF File: 10

Keywords: leverage, special purpose entities, regulatory arbitrage

JEL Classification: G12, G21, G24