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Working Papers

Credit Crunches and the Great Stagflation

Coauthors: Itamar Drechsler and Alexi Savov

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We show that severe credit crunches contributed to the four successive stagflationary cycles that characterize the Great Stagflation of 1965-1982. The crunches were the result of large outflows of deposits from the banking system that intensified whenever inflation increased. These deposit outflows were due to the Fed's policy of imposing a low ceiling on bank deposit rates, which eliminated the passthrough of the Fed funds rate to deposits and caused real deposit rates to become increasingly negative as inflation rose. Since credit is an input to firms' production, the high cost of credit during the crunches forced firms to raise prices and cut output and employment, i.e., they led to stagflation. Consistent with this theory, we find a tight relationship between declines in deposits and bank credit, the buildup of unfilled manufacturing orders and inflation, and declines in GDP growth, employment and inflation. We then test the theory in the cross section of manufacturing industries sorted by their dependence on bank financing and find that during the credit crunches, more finance-dependent firms raised prices and cut output more, held less inventory, and hired fewer employees. We similarly find these results for firms financed by banks located in areas that were more exposed to deposit outflows. Our findings imply that the supply shocks generated by the credit crunches were an important driver of the Great Stagflation.

The Financial Origins of the Rise and Fall of American Inflation

Coauthors: Itamar Drechsler and Alexi Savov

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We propose and test a new explanation for the rise and fall of the Great Inflation, a defining event in macroeconomics. We argue that its rise was due to the imposition of binding deposit rate ceilings under the law known as Regulation Q, and that its fall was due to the removal of these ceilings once the law was repealed. Deposits were the dominant form of saving at the time, hence Regulation Q suppressed the return to saving. This drove up aggregate demand, which pushed up inflation and further lowered the real return to saving, setting off an inflation spiral. The repeal of Regulation Q broke the spiral by sending deposit rates sharply higher. We document that the rise and fall of the Great Inflation lines up closely with the imposition and repeal of Regulation Q and the enormous changes in deposit rates and quantities it produced. We further test this explanation in the cross section using detailed data on local deposit markets and inflation. By exploiting four different sources of geographic variation, we show that the degree to which Regulation Q was binding has a large impact on local inflation, consistent with the hypothesis that Regulation Q explains the observed variation in aggregate inflation. We conclude that in the presence of financial frictions the Fed may be unable to control inflation regardless of its policy rule.

Marshall Blume Prize in Financial Research (First Prize), University of Pennsylvania, 2020


Specialization in Bank Lending: Evidence from Exporting Firms

Journal of Finance, forthcoming

Coauthors: Daniel Paravisini and Veronica Rappoport

View Abstract SlidesAppendix

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.

The Rise of Finance Companies and FinTech Lenders in Small Business Lending

Review of Financial Studies, 35(11), November 2022, 4859-4901

Coauthors: Manasa Gopal

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We document that finance companies and FinTech Lenders increased lending to small businesses after the 2008 financial crisis. We show that most of the increase substituted for a reduction in lending by banks. In counties where banks had a larger market share before the crisis, finance companies and FinTech lenders increased their lending more. By 2016, the increase in finance company and FinTech lending almost perfectly offset the decrease in bank lending. We control for firms' credit demand by examining lending by different lenders to the same firm, by comparing firms within the same narrow industry, and by comparing firms pledging the same collateral. Consistent with the substitution of bank lending with finance company and FinTech lending, we find limited long-term effects on employment, wages, new business creation, and business expansion. Our results show that finance companies and FinTech lenders are major suppliers of credit to small businesses and played an important role in the recovery from the 2008 financial crisis.

Editor Choice Article (Lead Article)

How Monetary Policy Shaped the Housing Boom

Journal of Financial Economics, 144(3), June 2022, Pages 992-1021

Coauthors: Itamar Drechsler and Alexi Savov

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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 differences in exposure to the deposits channel of monetary policy, we show that Fed tightening induced a large reduction in banks' deposit funding, which led banks to contract portfolio mortgage lending by 32%. However, this contraction was largely offset by substitution to privately-securitized (PLS) mortgages, led by nonbank originators. Fed tightening thus induced a shift in mortgage lending away from stable, insured deposit funding toward run-prone and fragile capital markets funding with little impact on overall lending. We find similar results during the most recent tightening cycle over 2014--2017 when PLS lending reemerged.

Banking on Deposits: Maturity Transformation without Interest Rate Risk

Journal of Finance, 76(3), June 2021, 1091-1143

Coauthors: Itamar Drechsler and Alexi Savov

View Abstract  Slides  U.S. Call Report Data  AppendixReplication Kit

We show that maturity transformation does not expose banks to interest rate risk---it hedges it. The reason is the deposit franchise, which allows banks to pay deposit rates that are low and insensitive to market interest rates. Hedging the deposit franchise requires banks to earn income that is also insensitive, i.e. to lend long-term at fixed rates. As predicted by this theory, we show that banks closely match the interest-rate sensitivities of their income and expenses, and that this insulates their equity from interest rate shocks. Our results provide an explanation for why banks supply long-term credit.

Brattle Group Prize (Distinguished Paper), 2021

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

Best paper on financial institutions, Western Finance Association, 2018

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  Slides  FinTech Lending Data  Appendix

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

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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

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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.

Amundi Pioneer Prize (Distinguished Paper), 2018

The Deposit Channel of Monetary Policy

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

Coauthors: Itamar Drechsler and Alexi Savov

View Abstract SlidesAppendixReplication DataU.S. Call Report DataNote on Begenau and Stafford (2022)

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

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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

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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.


Efficient Recapitalization

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

Coauthors: Thomas Philippon

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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.


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

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

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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.


Brattle Group Prize (First Paper), 2021

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, Bruce Tuckman, 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


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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