Lending Next to the Courthouse: The Salience of Adverse Events and Mortgage Lending Decisions
45 Pages Posted: 28 Oct 2019 Last revised: 31 Aug 2020
Date Written: August 30, 2020
Adverse housing market events can affect credit conditions not only by hurting the financial fundamentals of banks, but may also by changing the lending behaviors of individual loan officers. In this paper, we test the latter mechanism by analyzing loan-level mortgage applications from 2008 to 2016 and utilizing a distinctive setup in the home foreclosure process: foreclosure auctions are typically held live at the county courthouse, thus making the county-wise foreclosures more salient to loan officers working nearby. By comparing lending outcomes across loan applications within the same county and across branches of the same bank, we find that mortgage lending standards are more stringent when the decisions are made in bank branches next to county courthouses, resulting in higher rejection rates and smaller approved loan size. Accordingly, aggregating at the branch level, credit supply is significantly tighter at bank branches next to the courthouses relative to other branches of the same bank within the same county. We show that this salience effect on lending decisions and credit supply increases in the county-wise foreclosure intensity, and these effects are especially pronounced among high-risk borrowers and for branches belonging to small-sized banks. Our results are not driven by fundamental differences in borrower and branch characteristics of neighborhoods next to the courthouses and remain robust in a matched sample of branches and loan applications. Overall, our findings provide micro-level evidence that adverse news can have significant impacts on credit market outcomes by changing the risk preferences and beliefs of individual financial decision makers.
Keywords: salience, lending decisions, foreclosure
JEL Classification: G20, G21, D90
Suggested Citation: Suggested Citation