Home equity,mobility, and macroeconomic fluctuations

How does a fall in house prices affect real activity? This paper presents a tractable business cycle model in which a decline in house prices reduces geographical mobility, creating distortions in the labor market. This happens because homeowners face declines in their home equity levels, which makes it more difficult to provide the downpayment required for a new mortgage loan. Therefore, unemployed homeowners more often turn down job offers that would require them to move. The model can account for joint cyclical patterns in housing and labor market aggregates, and predicts a breakdown of the Beveridge curve in 2009. Counterfactual experiments are used to quantify the macroeconomic importance of the mobility channel during the Great Recession.     

Learning by lending

This paper studies bank learning through repeated interactions with borrowers from a new perspective. To understand learning by lending, we adapt a methodology from labor economics to analyze how loan contract terms evolve as banks acquire new information about borrowers. We construct “proxy” variables for this information using data from borrowers’ out-of-sample, future credit performance. Due to the timing of their construction, banks could not have used these variables directly to price loans. We nonetheless find that these proxies increasingly predict loan prices as relationships progress, even after controlling for possible omitted variable bias. Our methodology provides strong evidence that: (a) bank learning affects loan prices, and (b) relationship benefits are heterogeneous. In particular, higher quality borrowers face differentially lower spreads as their relationship with lenders develop – and banks learn about their quality – while lower quality borrowers see loan prices increase and their loan amounts fall. We further find suggestive evidence that banks incorporate CEO-specific information into loan prices.     

Credit Rationing,Income Exaggeration,and Adverse Selection in the Mortgage Market

We examine the role of borrower concerns about future credit availability in mitigating the effects of adverse selection and income misrepresentation in the mortgage market. We show that the majority of additional risk associated with “low‐doc” mortgages originated prior to the Great Recession was due to adverse selection on the part of borrowers who could verify income but chose not to. We provide novel evidence that these borrowers were more likely to inflate or exaggerate their income. Our analysis suggests that recent regulatory changes that have essentially eliminated the low‐doc loan product would result in credit rationing against self‐employed borrowers.     

What do a million observations have to say about loan defaults? Opening the black box of relationships

Using a unique dataset of more than 1 million loans made by 296 German banks, we evaluate the impact of many aspects of customer–bank relationships on loan default rates. Our research suggests a practical solution to reducing loan defaults for new customers: Have the customer open a simple transactions account – savings or checking account. Observe for some time and then decide whether to make a loan. Loans made under this model have lower default, as banks can use historical data about their borrowers to establish a baseline against which new client-related information can be evaluated. Banks assemble this historical information through relationships of different forms. We define relationships in many different ways to capture non-credit relationships, transaction accounts, as well as the depth and intensity of relationships, and find each of these can provide information that helps reduce default – even establishing a simple savings or checking account and observing the activity prior to loan granting can help reduce loan defaults. Our results show that banks with relationship-specific information act differently compared with banks that do not have this information both in screening and subsequent monitoring borrowers which helps reduce loan defaults.     

Managerial ability and bank‐loan pricing

This paper examines the impact of borrowers’ managerial ability on lenders’ bank‐loan pricing and the channels through which managerial ability affects bank‐loan pricing. Using a large sample of US bank loans, we provide evidence that higher managerial ability is associated with lower bank‐loan prices. This effect is stronger in firms with high information risk, suggesting that an important channel for managerial ability to affect bank‐loan pricing is through improved financial disclosure to mitigate information asymmetry. The relationship is also stronger for firms with weak business fundamentals, implying that another channel is through improved business performance. Of these two mechanisms, path analysis suggests that the business‐fundamentals mechanism is the more important channel through which managerial ability affects bank‐loan pricing.     

Differential Impacts of Structural and Cyclical Unemployment on Mortgage Default and Prepayment

The Great Recession (the fourth quarter of 2007 through the second quarter of 2009) has been characterized by high rates of foreclosures and unemployment. Using a sample of community reinvestment loans, we examine the impact of structural unemployment and cyclical unemployment on mortgage terminations (default and prepayment). We find that mortgage default and prepayment are more sensitive to changes in the structural component of the local unemployment rate than in the cyclical component. In addition, depending on whether structural unemployment rates are high or low, borrowers and lenders react differently to the incentives to terminate a loan.     

风险态度、合作行为与联保贷款契约:一个实验研究

本文应用实验室实验方法,研究了在不同贷款契约情况下,借款人风险态度等因素对合作水平(努力程度)的影响。研究发现:(1)联保贷款契约下参与者的努力水平之间存在正相关关系,且其努力水平显著高于个人责任契约下参与者的努力水平。说明联保贷款契约参与者存在较高的有条件合作行为;(2)在联保贷款契约下,风险喜好参与者的努力水平显著高于风险规避参与者。说明联保贷款契约对风险喜好参与者具有显著激励作用;(3)风险规避参与者的努力水平随实验期数增加而下降的速度比风险喜好参与者更快,风险规避参与者对联保贷款契约合作水平有较大危害。我们提出:小额贷款机构应当为风险喜好借款人提供联保贷款契约,并且避免风险规避的借款人与风险喜好的借款人组成联保贷款小组。对风险喜好借款人组成的联保贷款小组,联保贷款契约的期限可以较长。     

Information Losses in a Dynamic Model of Credit

This paper examines dynamic information losses associated with loan terminations. We assume that the aggregated returns of current borrowers contain information about the mean returns to future borrowers. In a competitive loan market, the value of this information is not fully internalized by individual borrowers and lenders, and loan decisions fail to be first best. Introducing heterogeneous borrowers, who know their own risk characteristics better than lenders, safer borrowers are less willing to borrow when risk premia rise. As they cease borrowing, the information generated in credit markets becomes noisier and this tends to increase risk premia. The model produces alternating and persistent periods of “tight” and “loose” credit.     

ARE FIRM‐ AND COUNTRY‐SPECIFIC GOVERNANCE SUBSTITUTES? EVIDENCE FROM FINANCIAL CONTRACTS IN EMERGING MARKETS

We investigate how borrowers’ corporate governance influences bank loan contracting terms in emerging markets and how this relation varies across countries with different country‐level governance. We find that borrowers with stronger corporate governance obtain favorable contracting terms with respect to loan amount, maturity, collateral requirements, and spread. Firm‐level and country‐level corporate governance are substitutes in writing and enforcing financial contracts. We also find that the distinctiveness of borrowers’ characteristics affect the relation between firm‐level corporate governance and loan contracting terms. Our findings are robust, irrespective of types of regression methods and specifications.     

Real estate prices and bank stability

Real estate prices can deviate from their fundamental value due to rigid supply, heterogeneity in quality, and various market imperfections, which have two contrasting effects on bank stability. Higher prices increase the value of collateral and net wealth of borrowers and thus reduce the likelihood of credit defaults. In contrast, persistent deviations from fundamentals may foster the adverse selection of increasingly risky creditors by banks seeking to expand their loan portfolios, which increases bank distress probabilities. We test these hypotheses using unique data on real estate markets and banks in Germany. House price deviations contribute to bank instability, but nominal house price developments do not. This finding corroborates the importance of deviations from the fundamental value of real estate, rather than just price levels or changes alone, when assessing bank stability.     

The Supply‐Side Determinants of Loan Contract Strictness

Using a measure of contract strictness based on the probability of a covenant violation, I investigate how lender‐specific shocks impact the strictness of the loan contract that a borrower receives. Banks write tighter contracts than their peers after suffering payment defaults to their own loan portfolios, even when defaulting borrowers are in different industries and geographic regions from the current borrower. The effects persist after controlling for bank capitalization, although bank equity compression is also associated with tighter contracts. The evidence suggests that recent defaults inform the lender's perception of its own screening ability, thereby impacting its contracting behavior.     

The Capitalization of Consumer Financing into Durable Goods Prices

Using loan‐level data on millions of used‐car transactions across hundreds of lenders, we study the consumer response to exogenous variation in credit terms. Borrowers offered shorter maturity decrease expenditures enough to offset 60% to 90% of the monthly payment increase. Most of this is driven by shifting toward lower‐quality cars, but affected borrowers offset 20% to 30% of a monthly payment shock by negotiating lower prices for equivalent cars. Our results suggest that durable goods prices adjust to reflect credit terms even at the individual level, with one year of additional loan maturity increasing a car's price by 2.8%.     

Monetary policy,bank competition and regional credit cycles: Evidence from a quasi-natural experiment

This paper examines how competition in the banking sector affects the transmission of monetary policy and the variation of credit expansion across regions in the United States. Using the U.S. branching deregulation between 1994 to 2008 as an exogenous change in banks’ competition, we analyze how bank competition affects monetary policy transmission through the bank lending channel. The results show that competition strengthens the impact of monetary policy on bank loan supply. We then show that states with a more deregulated banking sector were more affected by monetary conditions in the years leading to the Great Recession. Specifically, the effect of loose monetary conditions on the expansion of households’ debt was stronger in states that had fewer bank branching restrictions. The results suggest that variations in the level of bank competition may have amplified regional asymmetries in the years leading to the Great Recession.     

Strategic loan defaults and coordination: An experimental analysis

This paper experimentally studies the impact of bank and borrower fundamentals on loan repayment. We find that solvent borrowers are more likely to default strategically when the bank’s expected strength is low, although loan repayment is a Pareto dominant Nash equilibrium. Borrowers are also less likely to repay when other borrowers’ expected repayment capacity is low, regardless of banks’ fundamentals. We show that changes in expectations about bank and borrower fundamentals change the risk dominance properties of the borrowers’ coordination problem, and that these changes subsequently explain strategic defaults. For the individual borrower, loss aversion and negative past experiences reduce repayment, suggesting that bank failure can be contagious in times of distress.     

Fannie Mae and Freddie Mac: Risk-Taking and the Option to Change Strategy

The Journal of Real Estate Finance and Economics - We analyze causes of the surge in defaults experienced by Fannie Mae and Freddie Mac during the Great Recession. Our data are consistent with the...     

Foreign currency borrowing surrounding the global financial crisis: Evidence from Korea

We present a complete profile of firms’ foreign currency borrowing surrounding the 2007 global financial crisis. Employing extensive data from Korean firms during 2002–2012, we find that foreign currency borrowing is significantly related to firm attributes of export revenues, firm size, tangible assets and asset growth, as well as to macro-level factors. These results offer two important implications. First, macroeconomic factors alone cannot fully explain firms’ foreign currency borrowing. Second and more importantly, these firm attributes are indicative of a lower default probability and larger collateral value, which would not only facilitate borrowers’ access to foreign currency debt markets but also offer lenders a better protective cushion from possible loan defaults in the face of exchange rate changes and information asymmetry on borrowers’ credits. Period wise, asset-related firm attributes have more pronounced effects in the post- than pre-crisis period. We further show that banking regulations following the crisis effectively limit the access to foreign currency borrowing by Korean firms, most significantly by those belonging to large business groups.     

The flight home effect: Evidence from the syndicated loan market during financial crises

This paper shows that the collapse of the global market for syndicated loans during financial crises can in part be explained by a flight home effect whereby lenders rebalance their loan portfolios in favor of domestic borrowers. The home bias of lenders' loan origination increases by approximately 20% if the bank's home country experiences a banking crisis. This flight home effect is distinct from flight to quality because borrowers of different quality are equally affected. The results indicate that the home bias in capital allocation tends to increase when adverse economic shocks reduce the wealth of international investors.     

Regional redistribution through SBA guaranteed loan programs

We document and quantify a new implicit transfer mechanism in the SBA 7(a) loan program that redistributes funds between US states. We use SBA 7(a) loan data in conjunction with Dealscan private corporate loan data to show that SBA 7(a) loan interest rates are much less responsive to predicted local loan default risk compared to private corporate loans. This redistributes funds from states with low default risk to states with high default risk. These transfers are positively correlated with the severity of local economic shocks during the Great Recession and the COVID-19 Recession. Therefore, even though it was unintended, the interest rates on SBA 7(a) loans acted as an automatic stabilizer mitigating regional economic shocks.     

Liquidity and asset prices: A new monetarist approach

When lenders cannot force borrowers to repay debts, assets are often pledged to secure loans. In this paper borrowers lose collateral once they renege on debts, and exclusion of defaulters occurs probabilistically, with a higher probability implying better enforcement. Increased efficiency in enforcement reduces asset prices, while raising loan-to-value ratios. If the rise in loan-to-value ratios is the dominant effect, aggregate liquidity and output increase with the advance in enforcement. Inflation raises the repayment cost by increasing the loan rate, while raising the default cost through exclusion. Consequently, inflation raises loan-to-value ratios and output only when enforcement is sufficiently efficient.     

PCAOB international inspection access and debt contracting: Evidence from American Depositary Receipt firms

We examine whether the Public Company Accounting Oversight Board’s (PCAOB’s) international inspection access affects the usage of accounting-based debt covenants in bank loan contracts of American Depositary Receipt (ADR) borrowers. We show that there is an increase in the use of financial covenants in debt contracts after the auditor of an ADR borrower becomes subject to PCAOB inspections. We also document that lenders increase the usage of financial covenants only in loans to ADR borrowers domiciled in countries with weak home country intuitions, and the increase is more pronounced for ADR borrowers from countries without a local auditor regulatory oversight body. These findings suggest that PCAOB regulatory oversight enhances the perceived credibility of accounting numbers for debt contracting and serves as a substitute for the weak monitoring of auditors for ADR borrowers domiciled in countries with weak country institutions.