Panacea, Pandora’s Box, or Placebo: Feedback in Bank Mortgage-Backed Security Holdings and Fair Value Accounting

52 Pages Posted: 4 Jun 2011

See all articles by Gauri Bhat

Gauri Bhat

Southern Methodist University (SMU) - Accounting Department

Richard M. Frankel

Washington University in Saint Louis - Olin Business School

Xiumin Martin

Washington University in Saint Louis - Olin School of Business

Date Written: June 1, 2011

Abstract

We examine the relation between bank holdings of mortgage-backed securities (MBS) and MBS prices. Theory suggests feedback between MBS holdings and underlying asset markets can be aggravated by mark-to-market accounting. We measure feedback by the relation between asset returns and the changes in bank MBS holdings. Consistent with the existence of feedback effects related to mark-to-market, we find that for banks with high MBS, more nonperforming loans, and lower total capital ratio, changes in bank MBS positions are positively associated with changes in MBS prices and that this relation is reduced after the April 2009 mark-to-market rule clarification. To assess the effect of feedback on shareholder value, we test whether the stock-price response of banks to the announcement of the mark-to-market accounting rule clarification is associated with the intensity of feedback behavior. We find that the stock market reaction to the rule change is more positive for banks with more MBS, higher nonperforming loans and higher pre-rule-change feedback. We also find positive bond-price reactions to the rule change. Overall, our results suggest feedback related to mark-to-market accounting had a measurable effect on shareholder value.

Suggested Citation

Bhat, Gauri and Frankel, Richard M. and Martin, Xiumin, Panacea, Pandora’s Box, or Placebo: Feedback in Bank Mortgage-Backed Security Holdings and Fair Value Accounting (June 1, 2011). Journal of Accounting & Economics (JAE), Forthcoming. Available at SSRN: https://ssrn.com/abstract=1856727

Gauri Bhat

Southern Methodist University (SMU) - Accounting Department ( email )

United States
214-7682964 (Phone)

Richard M. Frankel

Washington University in Saint Louis - Olin Business School ( email )

One Brookings Drive
Campus Box 1133
St. Louis, MO 63130-4899
United States

Xiumin Martin (Contact Author)

Washington University in Saint Louis - Olin School of Business ( email )

Saint Louis, MO 63130
United States

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