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Deciphering the Liquidity and Credit Crunch 2007-08
"... This paper summarizes and explains the main events of the liquidity and credit crunch in 2007-08. Starting with the trends leading up to the crisis, I explain how these events unfolded and how four different amplification mechanisms magnified losses in the mortgage market into large dislocations and ..."
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Cited by 210 (14 self)
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This paper summarizes and explains the main events of the liquidity and credit crunch in 2007-08. Starting with the trends leading up to the crisis, I explain how these events unfolded and how four different amplification mechanisms magnified losses in the mortgage market into large dislocations and turmoil in financial markets.
2012b. Hazardous times for monetary policy: What do twenty-three million bank loans say about the effects of monetary policy on credit risk-taking? Barcelona GSE working paper
"... We are grateful to Philipp Hartmann and Frank Smets for helpful comments. We thank Marco lo Duca for excellent research assistance. Ongena acknowledges the hospitality of the European Central Bank. Any views expressed are only those of the authors and should not be attributed to the Bank of Spain, t ..."
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Cited by 117 (15 self)
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We are grateful to Philipp Hartmann and Frank Smets for helpful comments. We thank Marco lo Duca for excellent research assistance. Ongena acknowledges the hospitality of the European Central Bank. Any views expressed are only those of the authors and should not be attributed to the Bank of Spain, the European We investigate the impact of the stance and path of monetary policy on the level of credit risk of individual bank loans and on lending standards. We employ the Credit Register of the Bank of Spain that contains detailed monthly information on virtually all loans granted by all credit institutions operating in Spain during the last twenty-two years – generating almost twenty-three million bank loan records in total. Spanish monetary conditions were exogenously determined during the entire sample period. Using a variety of duration models we find that lower short-term interest rates prior to loan origination result in banks granting more risky new loans. Banks also soften their lending standards – they lend more to borrowers with a bad credit history and with high uncertainty. Lower interest rates, by contrast, reduce the credit risk of outstanding loans. Loan credit risk is maximized when both interest rates are very low prior to loan origination and interest
The Credibility Revolution in Empirical Economics: How Better Research Design is Taking the Con out of Econometrics
, 2010
"... This essay reviews progress in empirical economics since Leamer’s (1983) critique. Leamer highlighted the benefits of sensitivity analysis, a procedure in which researchers show how their results change with changes in specification or functional form. Sensitivity analysis has had a salutary but not ..."
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Cited by 76 (0 self)
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This essay reviews progress in empirical economics since Leamer’s (1983) critique. Leamer highlighted the benefits of sensitivity analysis, a procedure in which researchers show how their results change with changes in specification or functional form. Sensitivity analysis has had a salutary but not a revolutionary effect on econometric practice. As we see it, the credibility revolution in empirical work can be traced to the rise of a design-based approach that emphasizes the identification of causal effects. Design-based studies typically feature either real or natural experiments and are distinguished by their prima facie credibility and by the attention investigators devote to making the case for a causal interpretation of the findings their designs generate. Design-based studies are most often found in the microeconomic fields of Development, Education, Environment, Labor, Health, and Public Finance, but are still rare in Industrial Organization and Macroeconomics. We explain why IO and Macro would do well to embrace a design-based approach. Finally, we respond to the charge that the design-based revolution has overreached.
Unstable Banking
, 2009
"... We propose a theory of financial intermediaries operating in markets influenced by investor sentiment. In our model, banks make loans, securitize these loans, trade in them, or hold cash. They can also borrow money, using their security holdings as collateral. We embed such banks in a stylized finan ..."
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Cited by 73 (8 self)
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We propose a theory of financial intermediaries operating in markets influenced by investor sentiment. In our model, banks make loans, securitize these loans, trade in them, or hold cash. They can also borrow money, using their security holdings as collateral. We embed such banks in a stylized financial market, in which securitized loans may be mispriced, and investigate how banks allocate limited capital among the various activities, as well as how they choose their capital structure. Banks maximize profits, and there are no conflicts of interest between bank shareholders and creditors. The theory explains the cyclical behavior of credit and investment, but also accounts for the fundamental instability of banks operating in financial markets, especially when banks use leverage.
Originate-to-distribute Model and the subprime mortgage crisis. Review of Financial Studies 24:1881–915
"... An originate-to-distribute (OTD) model of lending, where the originator of a loan sells it to various third parties, was a popular method of mortgage lending before the onset of the subprime mortgage crisis. We show that banks with high involvement in the OTD market during the pre-crisis period orig ..."
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Cited by 58 (0 self)
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An originate-to-distribute (OTD) model of lending, where the originator of a loan sells it to various third parties, was a popular method of mortgage lending before the onset of the subprime mortgage crisis. We show that banks with high involvement in the OTD market during the pre-crisis period originated excessively poor-quality mortgages. This result is not explained away by differences in observable borrower quality, geographical location of the property, or the cost of capital of high- and low-OTD banks. Instead, our evidence supports the view that the originating banks did not expend resources in screen-ing their borrowers. The effect of OTD lending on poor mortgage quality is stronger for capital-constrained banks. Overall, we provide evidence that lack of screening incentives coupled with leverage-induced risk-taking behavior significantly contributed to the current subprime mortgage crisis. (JEL G11, G12, G13, G14) The recent crisis in the mortgage market is having an enormous impact on the world economy. While the popular press has presented a number of anecdotes and case studies, a body of academic research is fast evolving to understand the precise causes and consequences of this crisis (see Greenlaw et al. 2008;
Neglected risks, financial innovation, and financial fragility
- Journal of Financial Economics
, 2011
"... We present a standard model of financial innovation, in which intermediaries engineer securities with cash flows that investors seek, but modify two assumptions. First, investors (and possibly intermediaries) neglect certain unlikely risks. Second, investors demand securities with safe cash flows. F ..."
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Cited by 42 (5 self)
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We present a standard model of financial innovation, in which intermediaries engineer securities with cash flows that investors seek, but modify two assumptions. First, investors (and possibly intermediaries) neglect certain unlikely risks. Second, investors demand securities with safe cash flows. Financial intermediaries cater to these preferences and beliefs by engineering securities perceived to be safe but exposed to neglected risks. Because the risks are neglected, security issuance is excessive. As investors eventually recognize these risks, they fly back to safety of traditional securities and markets become fragile, even without leverage, precisely because the volume of new claims is excessive.
Informed and uninformed investment in housing: The downside of diversification
- Review of Financial Studies
, 2011
"... We show that mortgage lenders that concentrate in a few markets invest in more information than diversified lenders. First, concentrated lenders focus on the jumbo-loan market, where returns to information production are highest. Second, they ration credit less and retain more mortgages than diversi ..."
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Cited by 34 (5 self)
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We show that mortgage lenders that concentrate in a few markets invest in more information than diversified lenders. First, concentrated lenders focus on the jumbo-loan market, where returns to information production are highest. Second, they ration credit less and retain more mortgages than diversified lenders. Third, they have higher profits than diversified lenders, their profits vary less systematically, and their stock prices fell much less during the 2007-08 credit crisis. Both across markets and over time, the share of concentrated lending- that is, the share of informed lending- is negatively related to the recent housing price run-up. We therefore conclude that inadequate information production played a key role in the 2001-2008 real estate bubble and crash. I.
Rethinking Capital Regulation *
, 2008
"... of Australia, and the Australian Prudential Regulatory Authority for valuable comments. Yian Liu provided ..."
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Cited by 32 (5 self)
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of Australia, and the Australian Prudential Regulatory Authority for valuable comments. Yian Liu provided
Incentives and Tranche Retention in Securitisation: A Screening Model
, 2009
"... This paper examines the power of different contractual mechanisms to influence an originator’s choice of costly effort to screen borrowers when the originator plans to securitise its loans. The analysis focuses on three potential mechanisms: the originator holds a “vertical slice”, or share of the p ..."
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Cited by 31 (0 self)
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This paper examines the power of different contractual mechanisms to influence an originator’s choice of costly effort to screen borrowers when the originator plans to securitise its loans. The analysis focuses on three potential mechanisms: the originator holds a “vertical slice”, or share of the portfolio; the originator holds the equity tranche of a structured finance transaction; the originator holds the mezzanine tranche, rather than the equity tranche. These mechanisms will result in differing levels of screening, and the differences arise from varying sensitivities to a systematic risk factor. Equity tranche retention is not always the most effective mechanism. The equity tranche can be dominated by either a vertical slice or a mezzanine tranche if the probability of a downturn is likely and if the equity tranche is likely to be depleted in a downturn. In addition, a vertical slice is unlikely to dominate both the equity tranche and the mezzanine tranche, unless the vertical slice is very "thick".
2011), “The bank lending channel: lessons from the crisis
- Economic Policy
"... In 2011 all ECB publications feature a motif taken from the €100 banknote. NOTE: This Working Paper should not be reported as representing the views of the European Central Bank (ECB). The views expressed are those of the authors and do not necessarily reflect those of the ECB. This paper can be dow ..."
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Cited by 29 (1 self)
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In 2011 all ECB publications feature a motif taken from the €100 banknote. NOTE: This Working Paper should not be reported as representing the views of the European Central Bank (ECB). The views expressed are those of the authors and do not necessarily reflect those of the ECB. This paper can be downloaded without charge from
