Abstract

http://ssrn.com/abstract=2115537
 
 

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Did Capital Requirements and Fair Value Accounting Spark Fire Sales in Distressed Mortgage-Backed Securities?


Craig B. Merrill


Brigham Young University; Wharton Financial Institutions Center

Taylor Nadauld


Brigham Young University

Rene M. Stulz


Ohio State University (OSU) - Department of Finance; National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI)

Shane M. Sherlund


Federal Reserve Board of Governors

July 23, 2012

Fisher College of Business Working Paper No. 2012-03-12
Charles A. Dice Center Working Paper No. 2012-12

Abstract:     
Much attention has been paid to the large decreases in value of non-agency residential mortgage-backed securities (RMBS) during the financial crisis. Many observers have argued that the fall in prices was partly driven by decreased liquidity and fire sales. We investigate whether capital requirements and accounting rules at financial institutions contributed to the selling of RMBS at fire sale prices. For financial institutions subject to credit-sensitive capital requirements, capital requirements increase as an asset’s credit becomes impaired. When accounting rules require such an asset’s value to be marked-to-market and the fair value loss to be recognized in earnings, a capital-constrained firm can improve its capital position by selling the credit-impaired asset even if it has to accept a liquidity discount to do so. Using a sample of 5,014 repeat transactions of non-agency RMBS by insurance companies from 2006 to 2009, we show that insurance companies that became more capital-constrained because of operating losses (uncorrelated with RMBS credit quality) and also recognized fair value losses sold comparable RMBS at much lower prices than other insurance companies during the crisis.

Number of Pages in PDF File: 47

Keywords: Mark-to-market accounting, capital requirements, RMBS, fire sale, financial crisis

JEL Classification: G22, G28, G32, M41

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Date posted: July 24, 2012 ; Last revised: February 10, 2013

Suggested Citation

Merrill, Craig B. and Nadauld, Taylor and Stulz, Rene M. and Sherlund, Shane M., Did Capital Requirements and Fair Value Accounting Spark Fire Sales in Distressed Mortgage-Backed Securities? (July 23, 2012). Fisher College of Business Working Paper No. 2012-03-12. Available at SSRN: http://ssrn.com/abstract=2115537 or http://dx.doi.org/10.2139/ssrn.2115537

Contact Information

Craig B. Merrill
Brigham Young University ( email )
Provo, UT 84602
United States
(801) 422-4782 (Phone)
Wharton Financial Institutions Center ( email )
2306 Steinberg Hall-Dietrich Hall
3620 Locust Walk
Philadelphia, PA 19104
United States
Taylor Nadauld
Brigham Young University ( email )
Provo, UT 84602
United States
Rene M. Stulz (Contact Author)
Ohio State University (OSU) - Department of Finance ( email )
2100 Neil Avenue
Columbus, OH 43210-1144
United States
HOME PAGE: http://www.cob.ohio-state.edu/fin/faculty/stulz

National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
European Corporate Governance Institute (ECGI)
c/o ECARES ULB CP 114
B-1050 Brussels
Belgium
Shane M. Sherlund
Federal Reserve Board of Governors ( email )
20th and C Streets, NW
Mailstop 93
Washington, DC 20551
United States
202-452-3589 (Phone)
202-728-5887 (Fax)
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