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Working Papers

How Monetary Policy Shaped the Housing Boom

Coauthors: Itamar Drechsler and Alexi Savov

View Abstract Slides

Between 2003 and 2006, the Federal Reserve raised rates by 4.25%. Yet it was precisely during this period that the housing boom accelerated, fueled by rapid growth in mortgage lending. There is deep disagreement about how, or even if, monetary policy impacted the boom. Using heterogeneity in banks' exposures to the deposits channel of monetary policy, we show that Fed tightening induced a large reduction in banks' deposit funding, leading them to contract new on-balance-sheet lending for home purchases by 26%. However, an unprecedented expansion in privately-securitized loans, led by nonbanks, largely offset this contraction. Since privately-securitized loans are neither GSE-insured nor deposit-funded, they are run-prone, which made the mortgage market fragile. Consistent with our theory, the re-emergence of privately-securitized mortgages has closely tracked the recent increase in rates.

Banking on Deposits: Maturity Transformation without Interest Rate Risk

Coauthors: Itamar Drechsler and Alexi Savov

View Abstract Slides U.S. Call Report Data

We show that in stark contrast to conventional wisdom maturity transformation does not expose banks to significant interest rate risk. Aggregate net interest margins have been near-constant from 1955 to 2015, despite substantial maturity mismatch and wide variation in interest rates. We argue that this is due to banks' market power in deposit markets. Market power allows banks to pay deposit rates that are low and relatively insensitive to interest rate changes, but it also requires them to pay large operating costs. This makes deposits resemble fixed-rate liabilities. Banks hedge them by investing in long-term assets whose interest payments are also relatively insensitive to interest rate changes. Consistent with this view, we find that banks match the interest rate sensitivities of their expenses and income one for one. This relationship is robust to instrumenting for expense sensitivity using geographic variation in market power. Also consistent, we find that banks with lower expense sensitivity hold assets with substantially longer duration. Our results provide a novel explanation for the coexistence of deposit-taking and maturity transformation.

Yuki Arai Prize for the best research paper in finance at NYU Stern, 2018

Best paper on financial institutions, Western Finance Association, 2018

Specialization in Bank Lending: Evidence from Exporting Firms

Coauthors: Daniel Paravisini and Veronica Rappoport

View Abstract Slides

We develop an empirical approach for identifying specialization in bank lending using granular data on borrower activities. We illustrate the approach by characterizing bank specialization by export market, combining bank, loan, and export data for all firms in Peru. We find that all banks specialize in at least one export market, that specialization affects a firm's choice of new lenders and how to finance exports, and that credit supply shocks disproportionately affect a firm's exports to markets where the lender specializes in. Thus, bank market-specific specialization makes credit difficult to substitute, with consequences for competition in credit markets and the transmission of credit shocks to the economy.

Publications

The Role of Technology in Mortgage Lending

Review of Financial Studies 32(5), May 2019, 1854-1899

Coauthors: Andreas Fuster, Matthew Plosser, and James Vickery

View Abstract SlidesAppendix

Technology-based ("FinTech") lenders increased their market share of U.S. mortgage lending from 2% to 8% from 2010 to 2016. Using loan-level data on mortgage applications and originations, we show that FinTech lenders process mortgage applications 20% faster than other lenders, controlling for observable characteristics. Faster processing does not come at the cost of higher defaults. FinTech lenders adjust supply more elastically than other lenders in response to exogenous mortgage demand shocks. In areas with more FinTech lending, borrowers refinance more, especially when it is in their interest to do so. We find no evidence that FinTech lenders target borrowers with low access to finance.

Liquidity, Risk Premia, and the Financial Transmission of Monetary Policy

Coauthors: Itamar Drechsler and Alexi Savov

Annual Review of Financial Economics 10, November 2018, 309-328

View Abstract

In recent years there has been a resurgence of research on the transmission of monetary policy through the financial system, fueled in part by empirical findings showing that monetary policy affects asset prices and the financial system in ways not explained by the New Keynesian paradigm. In particular, monetary policy appears to impact risk premia in stock and bond prices, and to effectively control the liquidity premium in the economy (the cost of holding liquid assets). We review these findings and recent theories proposed to explain them, and outline a conceptual framework that unifies them. The framework revolves around the central role of liquidity in risk sharing, and how monetary policy governs its production and use within the financial sector.

A Model of Monetary Policy and Risk Premia

Journal of Finance 71(1), February 2018, 317-373

Coauthors: Itamar Drechsler and Alexi Savov

View Abstract Slides

We develop a dynamic asset pricing model in which monetary policy affects the risk premium component of the cost of capital. Risk-tolerant agents (banks) borrow from risk-averse agents (i.e. take deposits) to fund levered investments. Leverage exposes banks to funding risk, which they insure by holding liquidity buffers. By changing the nominal rate the central bank influences the liquidity premium in financial markets, and hence the cost of taking leverage. Lower nominal rates make liquidity cheaper and raise leverage, resulting in lower risk premia and higher asset prices, volatility, investment, and growth. We analyze forward guidance, a “Greenspan put”, and the yield curve.

The Deposit Channel of Monetary Policy

Quarterly Journal of Economics 132(4), November 2017, 1819-1876

Coauthors: Itamar Drechsler and Alexi Savov

View Abstract SlidesAppendixU.S. Call Report Data

We present a new channel for the transmission of monetary policy, the deposits channel. We show that when the Fed funds rate rises, banks widen the spreads they charge on deposits, and deposits flow out of the banking system. We present a model where this is due to market power in deposit markets. Consistent with the market power mechanism, deposit spreads increase more and deposits flow out more in concentrated markets. This is true even when we control for lending opportunities by only comparing different branches of the same bank. Since deposits are the main source of liquid assets for households, the deposits channel can explain the observed strong relationship between the liquidity premium and the Fed funds rate. Since deposits are also a uniquely stable funding source for banks, the deposits channel impacts bank lending. When the Fed funds rate rises, banks that raise deposits in concentrated markets contract their lending by more than other banks. Our estimates imply that the deposits channel can account for the entire transmission of monetary policy through bank balance sheets.

SFS Cavalcde 2015, Best Paper in Corporate Finance

Glucksman Institute Research Prize for Best Paper in Finance at NYU Stern, 2016

How Safe are Money Market Funds?

Quarterly Journal of Economics, 128 (3), August 2013, 1073-1122

Coauthors: Marcin Kacperczyk

View Abstract

We examine the risk-taking behavior of money market funds during the financial crisis of 2007 to 2010. We find that (1) money market funds experienced an unprecedented expansion in their risk-taking opportunities; (2) funds had strong incentives to take on risk because fund inflows were highly responsive to fund yields; (3) funds sponsored by financial intermediaries with more money fund business took on more risk; and (4) funds suffered runs as a result of their risk taking. This evidence suggests that money market funds lack safety because they have strong incentives to take on risk when the opportunity arises and are vulnerable to runs.

Securitization Without Risk Transfer

Journal of Financial Economics, 107(3), March 2013, 515-536 (Lead Article)

Coauthors: Viral Acharya and Gustavo Suarez

View Abstract

We analyze asset-backed commercial paper conduits, which experienced a shadowbanking run and played a central role in the early phase of the financial crisis of 2007 to 2009. We document that commercial banks set up conduits to securitize assets worth $1.3 trillion while insuring the newly securitized assets using explicit guarantees. We show that regulatory arbitrage was an important motive behind setting up conduits. In particular, the guarantees were structured so as to reduce regulatory capital requirements, more so by banks with less capital, and while still providing recourse to bank balance sheets for outside investors. Consistent with such recourse, we find that conduits provided little risk transfer during the run, as losses from conduits remained with banks instead of outside investors and banks with more exposure to conduits had lower stock returns.

Data

Efficient Recapitalization

Journal of Finance, 68(1), February 2013, 1-42 (Lead Article)

Coauthors: Thomas Philippon

View Abstract

We analyze government interventions to recapitalize a banking sector that restricts lending to firms because of debt overhang. We find that the efficient recapitalization program injects capital against preferred stock plus warrants and conditions implementation on sufficient bank participation. Preferred stock plus warrants reduces opportunistic participation by banks that do not require recapitalization, although conditional implementation limits free riding by banks that benefit from lower credit risk because of other banks' participation. Efficient recapitalization is profitable if the benefits of lower aggregate credit risk exceed the cost of implicit transfers to bank debt holders.

Appendix

The International Transmission of Bank Liquidity Shocks: Evidence from an Emerging Market

Journal of Finance, 67(3), June 2012, 897-932

View Abstract

I exploit the 1998 Russian default as a negative liquidity shock to international banks and analyze its transmission to Peru. I find that after the shock international banks reduce bank-to-bank lending to Peruvian banks and Peruvian banks reduce lending to Peruvian firms. The effect is strongest for domestically owned banks that borrow internationally, intermediate for foreign-owned banks, and weakest for locally funded banks. I control for credit demand by examining firms that borrow from several banks. These results suggest that international banks transmit liquidity shocks across countries and that negative liquidity shocks reduce bank lending in affected countries.

Appendix

Winner, 2012 Brattle Prize, First Prize Paper for the best corporate finance paper published in the Journal of Finance

When Safe Proved Risky: Commercial Paper During the Financial Crisis of 2007-2009

Journal of Economic Perspectives, Winter 2010, 24(1), 29-50

Coauthors: Marcin Kacperczyk

Book Chapters, Conference Proceedings, and Non-Refereed Publications

Bank Capital Regulation and the Off-Ramp

In Regulating Wall Street: Choice Act versus Dodd-Frank, Eds. Matthew Richardson, Kermit Schoenholz, BruceTuckman, and Larry J. White, March 2017

A Tale of Two Overhangs: The Nexus of Financial Sector and Sovereign Credit Risks

Banque de France Financial Stability Review,, 16, April 2012

An Example of Efficient Recapitalization under Debt Overhang

In 46th Annual Conference on Bank Structure and Competition, Conference Proceedings, Federal Reserve Bank of Chicago, May 2010

Money Market Funds: How to Avoid Breaking the Buck

In Regulating Wall Street, Eds. Viral Acharya, Thomas Cooley, Matthew Richardson and Ingo Walter, John Wiley & Sons, November 2010

Coauthors: Marcin Kacperczyk

Blog

Does Less Market Entry Regulation Generate More Entrepreneurs? Evidence from a Regulatory Reform in Peru

In International Differences in Entrepreneurship, Eds. Joshua Lerner and Antoinette Schoar, University of Chicago Press, 2010

Coauthors: Sendhil Mullainathan

How Banks Played the Leverage Game

In Restoring Financial Stability: How to Repair a Failed System, Eds. Viral Acharya and Matthew Richardson, John Wiley & Sons, March 2009

Coauthors: Viral Acharya

New Evidence on the International Bank Lending Channel

44th Annual Conference on Bank Structure and Competition, Conference Proceedings, May 2008, Federal Reserve Bank of Chicago

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