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Working Papers 2018: Abstracts

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18-28: Appraising Home Purchase Appraisals by Paul S. Calem, Lauren Lambie-Hanson, Leonard I. Nakamura, and Jeanna H. Kenney

Home appraisals are produced for millions of residential mortgage transactions each year, but appraised values are rarely below the purchase contract price: Some 30% of appraisals in our sample are exactly at the home price (with less than 10% of them below it). We lay out a basic theoretical framework to explain how appraisers’ incentives within the institutional framework that governs mortgage lending lead to information loss in appraisals (that is, appraisals set equal to the contract price). Consistent with the theory, we observe a higher frequency of appraisal equal to contract price and a higher incidence of mortgage default at loan-to-value boundaries (notches) above which mortgage insurance rates increase. Appraisals appear to be less informative for default risk measurement compared with automated valuation models.
Supersedes Working Paper 17-23.
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18-27: Effects of the Community Reinvestment Act (CRA) on Small Business Lending by Lei Ding, Hyojung Lee, and Raphael W. Bostic

This study provides new evidence on the effectiveness of the Community Reinvestment Act (CRA) on small business lending by focusing on a sample of neighborhoods with changed CRA eligibility status across the country because of an exogenous policy shock in 2013. The results of difference-in-differences analysis provide consistent evidence that the CRA promotes small business lending, especially in terms of number of loan originations, in lower-income neighborhoods. The generally positive effects of the CRA are sensitive to the types of CRA treatment. Losing CRA eligibility status has a relatively larger effect on small business lending activities, while the effects of newly gaining CRA eligibility are less pronounced. The results are fairly robust when alternative sample periods and control groups are used.
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18-26: Redefault Risk in the Aftermath of the Mortgage Crisis: Why Did Modifications Improve More Than Self-Cures? by Paul Calem, Julapa Jagtiani, and Raman Maingi

This paper examines changes in the redefault rate of mortgages that were selected for modification during 2008–2011, compared with that of similarly situated self-cured mortgages. We find a large decline in the redefault rate of both modified and self-cured mortgages over this period, but the improvement was greatest for modifications. Our analysis has identified several important factors contributing to the greater improvement for modified loans, including an increasing share of principal-reduction modifications, which appear to be more effective than other types of modification and increasingly generous modification terms (larger payment reductions). The favorable impacts of principal and payment reductions on household finances were enhanced by improving economic conditions, resulting in more effective modifications. Even after accounting for these factors, we still observe a larger decline in the redefault rate for modifications compared with similarly situated self-cured loans. This residual effect may reflect servicer "learning-by-doing"; that is, servicers gained knowledge as modification activity ramped up, resulting in more successful modification programs for later cohorts.
Supersedes Working Paper 18-02.
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18-25: Inference in Bayesian Proxy-SVARs by Jonas E. Arias, Juan F. Rubio-Ramírez, and Daniel F. Waggoner

Motivated by the increasing use of external instruments to identify structural vector autoregressions (SVARs), we develop algorithms for exact finite sample inference in this class of time series models, commonly known as proxy-SVARs. Our algorithms make independent draws from the normal-generalized-normal family of conjugate posterior distributions over the structural parameterization of a proxy-SVAR. Importantly, our techniques can handle the case of set identification and hence they can be used to relax the additional exclusion restrictions unrelated to the external instruments often imposed to facilitate inference when more than one instrument is used to identify more than one equation as in Mertens and Montiel-Olea (2018).
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18-24: The Effects of Competition in Consumer Credit Markets by Stefan Gissler, Rodney Ramcharan, and Edison Yu

Using changes in financial regulation that create exogenous entry in some consumer credit markets, we find that increased competition induces banks to become more specialized and efficient, while deposit rates increase and borrowing costs for riskier collateral decline. However, shadow banks change their credit policy when faced with more competition and aggressively expand credit to riskier borrowers at the extensive margin, resulting in higher default rates. These results show how the form of intermediation can shape economic fluctuations. They also suggest that increased competition can lead to large changes in credit policy at institutions outside the traditional supervisory umbrella, possibly creating a less stable financial system.
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18-23: Dynamic Pricing of Credit Cards and the Effects of Regulation by Suting Hong, Robert M. Hunt, and Konstantinos Serfes

We construct a two-period model of revolving credit with asymmetric information and adverse selection. In the second period, lenders exploit an informational advantage with respect to their own customers. Those rents stimulate competition for customers in the first period. The informational advantage the current lender enjoys relative to its competitors determines interest rates, credit supply, and switching behavior. We evaluate the consequences of limiting the repricing of existing balances as implemented by recent legislation. Such restrictions increase deadweight losses and reduce ex-ante consumer surplus. The model suggests novel approaches to identify empirically the effects of this law.
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18-22: Peers’ Income and Financial Distress: Evidence from Lottery Winners and Neighboring Bankruptcies by Sumit Agarwal, Vyacheslav Mikhed, and Barry Scholnick

We examine whether relative income differences among peers can generate financial distress. Using lottery winnings as plausibly exogenous variations in the relative income of peers, we find that the dollar magnitude of a lottery win of one neighbor increases subsequent borrowing and bankruptcies among other neighbors. We also examine which factors may mitigate lenders’ bankruptcy risk in these neighborhoods. We show that bankruptcy filers obtain more secured but not unsecured debt, and lenders provide additional credit to low-risk but not high-risk debtors. In addition, we find evidence consistent with local lenders taking advantage of soft information to mitigate credit risk.
Supersedes Working Paper 18-16.
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18-21: Financial Contracting with Enforcement Externalities by Lukasz A. Drozd and Ricardo Serrano-Padial

We study the negative feedback loop between the aggregate default rate and the efficacy of enforcement in a model of debt-financed entrepreneurial activity. The novel feature of our model is that enforcement capacity is accumulated ex ante and thus subject to depletion ex post. We characterize the effect of shocks that deplete enforcement resources on the aggregate default rate and credit supply. In the model default decisions by entrepreneurs are strategic complements, leading to multiple equilibria. We propose a global game selection to overcome equilibrium indeterminacy and show how shocks that deplete enforcement capacity can lead to a spike in the aggregate default rate and trigger credit rationing.
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18-20: Market-making with Search and Information Frictions by Benjamin Lester, Ali Shourideh, Venky Venkateswaran, and Ariel Zetlin-Jones

We develop a dynamic model of trading through market-makers that incorporates two canonical sources of illiquidity: trading (or search) frictions, which imply that market-makers have some amount of market power; and information frictions, which imply that market-makers face some degree of adverse selection. We use this model to study the effects of various technological innovations and regulatory initiatives that have reduced trading frictions in over-the-counter markets. Our main result is that reducing trading frictions can lead to less liquidity, as measured by bid-ask spreads. The key insight is that more frequent trading—or more competition among dealers—makes traders’ behavior less dependent on asset quality. As a result, dealers learn about asset quality more slowly and set wider bid-ask spreads to compensate for this increase in uncertainty.
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18-19: Inflation and Real Activity with Firm Level Productivity Shocks by Michael Dotsey and Alexander L. Wolman

In the last fifteen years there has been an explosion of empirical work examining price setting behavior at the micro level. The work has in turn challenged existing macro models that attempt to explain monetary nonneutrality, because these models are generally at odds with much of the micro price data. A second generation of models, with fixed costs of price adjustment and idiosyncratic shocks, is more consistent with this micro data. Nonetheless, ambiguity remains about the extent of nonneutrality that can be attributed to costly price adjustment. Using a model that matches many features of the micro data, our paper takes a step toward eliminating that ambiguity, at the same time highlighting the challenges that remain.

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18-18 Revised: How Important Are Local Community Banks to Small Business Lending? Evidence from Mergers and Acquisitions by Julapa Jagtiani and Raman Quinn Maingi

The authors investigate the shrinking community banking sector and the impact on local small business lending (SBL) in the context of mergers and acquisitions. From all mergers that involved community banks, they examine the varying impact on SBL depending on the local presence of the acquirers’ and the targets’ operations prior to acquisitions. Our results indicate that, relative to counties where the acquirer had operations before the merger, local SBL declined significantly more in counties where only the target had operations before the merger. This result holds even after controlling for the general local SBL market or local economic trends. These findings are consistent with an argument that SBL funding has been directed (after the mergers) toward the acquirers’ counties. The authors find even stronger evidence during and after the financial crisis. Overall, the authors find evidence that local community banks have continued to play an important role in providing funding to local small businesses. The absence of local community banks that became a target of a merger or acquisition by nonlocal acquirers has, on average, led to local SBL credit gaps that were not filled by the rest of the banking sector.
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18-17: "Free" Internet Content: Web 1.0, Web 2.0, and the Sources of Economic Growth by Leonard Nakamura, Jon Samuels, and Rachel Soloveichik

The Internet has evolved from Web 1.0, with static web pages and limited interactivity, to Web 2.0, with dynamic content that relies on user engagement. This change increased production costs significantly, but the price charged for Internet content has generally remained the same: zero. Because no transaction records the "purchase" of this content, its value is not reflected in measured growth and productivity. To capture the contribution of the "free" Internet, we model the provision of "free" content as a barter transaction between the content users and the content creators, and we value this transaction at production cost. When we incorporate this implicit transaction into U.S. gross domestic product (GDP), productivity, and household accounts, we find that including “free” content raises estimates of growth, but not nearly enough to reverse the recent slowdown.
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18-16: Does the Relative Income of Peers Cause Financial Distress? Evidence from Lottery Winners and Neighboring Bankruptcies by Sumit Agarwal, Vyacheslav Mikhed, and Barry Scholnick

Superseded by Working Paper 18-22.
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18-15 Revised: The Roles of Alternative Data and Machine Learning in Fintech Lending: Evidence from the LendingClub Consumer Platform by Julapa Jagtiani and Catharine Lemieux

Fintech has been playing an increasing role in shaping financial and banking landscapes. There have been concerns about the use of alternative data sources by fintech lenders and the impact on financial inclusion. We compare loans made by a large fintech lender and similar loans that were originated through traditional banking channels. Specifically, we use account-level data from LendingClub and Y-14M data reported by bank holding companies with total assets of $50 billion or more. We find a high correlation with interest rate spreads, LendingClub rating grades, and loan performance. Interestingly, the correlations between the rating grades and FICO scores have declined from about 80 percent (for loans that were originated in 2007) to only about 35 percent for recent vintages (originated in 2014–2015), indicating that nontraditional alternative data have been increasingly used by fintech lenders. Furthermore, we find that the rating grades (assigned based on alternative data) perform well in predicting loan performance over the two years after origination. The use of alternative data has allowed some borrowers who would have been classified as subprime by traditional criteria to be slotted into “better” loan grades, which allowed them to get lower priced credit. In addition, for the same risk of default, consumers pay smaller spreads on loans from LendingClub than from credit card borrowing.
Supersedes Working Paper 17-17.
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18-14 Revised: Commuting, Labor, and Housing Market Effects of Mass Transportation: Welfare and Identification by Christopher Severen

Using a panel of tract-level bilateral commuting flows, I estimate the causal effect of Los Angeles Metro Rail on commuting between connected locations. Unique data, in conjunction with a spatial general equilibrium model, isolate commuting benefits from other channels. A novel strategy interacts local innovations with intraurban geography to identify all model parameters (local housing and labor elasticities). Metro Rail connections increase commuting between locations containing (adjacent to) stations by 15% (10%), relative to control routes selected using proposed and historical rail networks. Other margins are not affected. Elasticity estimates suggest relatively inelastic mobility and housing supply. Metro Rail increases welfare $146 million annually by 2000, less than both operational subsidies and the annual cost of capital. More recent data show some additional commuting growth.
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18-13: Do Fintech Lenders Penetrate Areas That Are Underserved by Traditional Banks? by Julapa Jagtiani and Catharine Lemieux

Fintech has been playing an increasing role in shaping financial and banking landscapes. In this paper, we use account-level data from LendingClub and Y-14M data reported by U.S. banks with assets over $50 billion to examine whether the fintech lending platform could expand credit access to consumers. We find that LendingClub’s consumer lending activities have penetrated areas that may be underserved by traditional banks, such as in highly concentrated markets and in areas that have fewer bank branches per capita. We also find that the portion of LendingClub loans increases in areas where the local economy is not performing well.
Supersedes Working Paper 17-17.
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18-12: Shrinking Networks: A Spatial Analysis of Bank Branch Closures by Anna Tranfaglia

As more consumers take advantage of online banking services, branch networks are declining across the country. Limited attention has been given to identifying any possible spatial patterns of branch closures and, more importantly, the community demographics where branches close their doors. This analysis uses an innovative spatial statistics concept to study financial services: Using data from 2010 to 2016, a random labelling test is conducted to understand branch closure clustering in the Philadelphia, Chicago, and Baltimore metropolitan statistical areas (MSAs). Additionally, spatial autocorrelation is tested, and an MSA-level spatial regression analysis is done to see if there is a pattern to branch closures in metropolitan areas. I find evidence of branch closure clusters in the Chicago and Philadelphia MSAs; however, this spatial pattern is only observable within the suburbs, not the primary city itself. Using a random labelling test is a methodological innovation in regional economic studies and propels our understanding of banking deserts and underserved neighborhoods.
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18-11: Does Scale Matter in Community Bank Performance? Evidence Obtained by Applying Several New Measures of Performance by Joseph P. Hughes, Julapa Jagtiani, Loretta J. Mester, and Choon-Geol Moon

We consider how size matters for banks in three size groups: banks with assets of less than $1 billion (small community banks), banks with assets between $1 billion and $10 billion (large community banks), and banks with assets between $10 billion and $50 billion (midsize banks). Community banks have potential advantages in relationship lending compared with large banks. However, increases in regulatory compliance and technological burdens may have disproportionately increased community banks’ costs, raising concerns about small businesses’ access to credit. Our evidence suggests that (1) the average costs related to regulatory compliance and technology decrease with size; (2) while small community banks exhibit relatively more valuable investment opportunities, larger community banks and midsize banks exploit theirs more efficiently and achieve better financial performance; (3) unlike small community banks, large community banks have financial incentives to increase lending to small businesses; and (4) for business lending and commercial real estate lending, large community banks and midsize banks assume higher inherent credit risk and exhibit more efficient lending. Thus, concern that small business lending would be adversely affected if small community banks find it beneficial to increase their scale is not supported by our results.
Supersedes Working Paper 16-15.
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18-10: A Model of the Federal Funds Market: Yesterday, Today, and Tomorrow by Gara Afonso, Roc Armenter, and Benjamin Lester

The landscape of the federal funds market changed drastically in the wake of the Great Recession as large-scale asset purchase programs left depository institutions awash with reserves, and new regulations made it more costly for these institutions to lend. As traditional levers for implementing monetary policy became less effective, the Federal Reserve introduced new tools to implement the target range for the federal funds rate, changing this landscape even more. In this paper, we develop a model that is capable of reproducing the main features of the federal funds market, as observed before and after 2008, in a single, unified framework. We use this model to quantitatively evaluate the evolution of interest rates and trading volume in the federal funds market as the supply of aggregate reserves shrinks. We find that these outcomes are highly sensitive to the dynamics of the distribution of reserves across banks.
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18-09: The Interplay Among Financial Regulations, Resilience, and Growth by Franklin Allen, Itay Goldstein, and Julapa Jagtiani

Interconnectedness has been an important source of market failures, leading to the recent financial crisis. Large financial institutions tend to have similar exposures and thus exert externalities on each other through various mechanisms. Regulators have responded by putting more regulations in place with many layers of regulatory complexity, leading to ambiguity and market manipulation. Mispricing risk in complex models and arbitrage opportunities through regulatory loopholes have provided incentives for certain activities to become more concentrated in regulated entities and for other activities to move into new areas in the shadow banking system. How can we design an effective regulatory framework that would perfectly rule out bank runs and TBTF (too big to fail) and to do so without introducing incentives for financial firms to take excessive risk? It is important for financial regulations to be coordinated across regulatory entities and jurisdictions and for financial regulations to be forward looking, rather than aiming to address problems of the past.
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18-08: Accounting for the Sources of Macroeconomic Tail Risks by Enghin Atalay, Thorsten Drautzburg, and Zhenting Wang

Using a multi-industry real business cycle model, we empirically examine the microeconomic origins of aggregate tail risks. Our model, estimated using industry-level data from 1972 to 2016, indicates that industry-specific shocks account for most of the third and fourth moments of GDP growth.
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18-07: On the Economics of Digital Currencies by Jesús Fernández-Villaverde and Daniel Sanches

Can a monetary system in which privately issued cryptocurrencies circulate as media of exchange work? Is such a system stable? How should governments react to digital currencies? Can these currencies and government-issued money coexist? Are cryptocurrencies consistent with an efficient allocation? These are some of the important questions that the sudden rise of cryptocurrencies has brought to contemporary policy discussions. To answer these questions, we construct a model of competition among privately issued fiat currencies. We find that a purely private arrangement fails to implement an efficient allocation, even though it can deliver price stability under certain technological conditions. Currency competition creates problems for monetary policy implementation under conventional methods. However, it is possible to design a policy rule that uniquely implements an efficient allocation by driving private currencies out of the market. We also show that unique implementation of an efficient allocation can be achieved without government intervention if productive capital is introduced.
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18-06: Declining Labor Turnover and Turbulence by Shigeru Fujita

The rate of job loss has been on a secular decline for the last four decades or longer. Changes in demographics or industry composition do not account for the trend. This paper seeks to identify possible sources of this decline using a simple labor matching model with two types of workers, experienced and inexperienced, where the former type faces a risk of skill loss during unemployment. When the skill loss occurs, the worker is required to restart his career and thus suffers a drop in his wage. I show that a higher risk of skill loss results in a lower job separation rate, because workers are willing to accept lower wages in exchange for keeping their jobs. Various other potential hypotheses are also examined in the model.
Supersedes Working Paper 15-29.
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18-05: Screening on Loan Terms: Evidence from Maturity Choice in Consumer Credit by Andrew Hertzberg, Andres Liberman, and Daniel Paravisini

We exploit a natural experiment in the largest online consumer lending platform to provide the first evidence that loan terms, in particular maturity choice, can be used to screen borrowers based on their private information. We compare two groups of observationally equivalent borrowers who took identical unsecured 36-month loans; for only one of the groups, a 60-month loan was also available. When a long-maturity option is available, fewer borrowers take the short-term loan, and those who do default less. Additional findings suggest borrowers self-select on private information about their future ability to repay.
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18-04 Revised: The Economics of Debt Collection: Enforcement of Consumer Credit Contracts by Viktar Fedaseyeu and Robert Hunt

Creditors often outsource the task of obtaining repayment from defaulting borrowers to third-party debt collectors. We argue that by hiring third-party debt collectors, creditors can avoid competing in terms of their debt collection practices. This explanation fits several empirical facts about third-party debt collection and is consistent with the evidence that third-party debt collectors use harsher debt collection practices than original creditors. Our model shows that the impact of third-party debt collectors on consumer welfare depends on the riskiness of the pool of borrowers and provides insights into which policy interventions may improve the functioning of the debt collection market.
Supersedes Working Paper 15-43.
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18-03: Did the ACA’s Dependent Coverage Mandate Reduce Financial Distress for Young Adults? by Nathan Blascak and Vyacheslav Mikhed

We analyze whether the passage of the Affordable Care Act's dependent coverage mandate in 2010 reduced financial distress for young adults. Using nationally representative, anonymized consumer credit report information, we find that young adults covered by the mandate lowered their past due debt, had fewer delinquencies, and had a reduced probability of filing for bankruptcy. These effects are stronger in geographic areas that experienced higher uninsured rates for young adults prior to the mandate's implementation. Our estimates also show that some improvements are transitory because they diminish after an individual ages out of the mandate at age 26.
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18-02: Redefault Risk in the Aftermath of the Mortgage Crisis: Why Did Modifications Improve More Than Self-Cures? by Paul Calem, Julapa Jagtiani, Raman Maingi

Superseded by Working Paper 18-26.
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18-01: Greed as a Source of Polarization by Igor Livshits and Mark L.J. Wright

The political process in the United States appears to be highly polarized: evidence from voting patterns finds that the political positions of legislators have diverged substantially, while the largest campaign contributions come from the most extreme lobby groups and are directed to the most extreme candidates. Is the rise in campaign contributions the cause of the growing polarity of political views? In this paper, we show that, in standard models of lobbying and electoral competition, a free-rider problem amongst potential contributors leads naturally to a divergence in campaign contributors without any divergence in candidates' policy positions. However, we go on to show that a modest departure from standard assumptions — allowing candidates to directly value campaign contributions (because of "ego rents" or because lax auditing allows them to misappropriate some of these funds) — delivers the ability of campaign contributions to cause policy divergence.
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