econ 350: october 15 chapter 8: economic analysis of financial structure cra newly posted article
TRANSCRIPT
Econ 350: October 15
Chapter 8: Economic Analysis of Financial Structure
CRA Newly posted article
Moral Values
McCloskey 2006 The Bourgeois Virtues: Ethics for an Age of
Commerce Since 1800 income (in real terms has gone
from $3 to $137) How to account for how well off we are?
Ethical argument: Commerce requires reliability. Reasonableness,
integrity. Adam Smith the moral philosopher.
Asymmetric information Adverse Selection
unknown quality causes unraveling: Lemons problem
Solutions Private production and sale of information Government regulation to increase information Financial intermediation
Collateral and net worth
Moral hazard: principal &agent have different goals Solutions
Compensation schemes align incentives
Don’t be a principal (use debt contracts instead of equity)
Bottom Line:
We devote a lot of resources to combating adverse selection and moral hazard.
Many of the institutions and “stylized facts” in our economy arise from or in response to these informational problems.
Did the CRA cause the crisis? Community
Reinvestment Act Legislation is a response
to “redlining” Banks refuse to lend to
entire (low-income) neighborhoods
1977: Federal government requires banks to lend in neighborhoods where they take deposits If they want to participate in
FDIC deposit insurance
CRA and the financial crisis
Did CRA requirements force banks to make poor loans? What is the counterfactual? What data do we need?
How do we model foreclosure?
Stylized facts, what causes foreclosure? Characteristics of borrower Characteristics of loan Characteristics of lender Characteristics of housing market other stuff?
How do we model foreclosure?
Terminology Probability of foreclosure “is a function of” other things Foreclosure is the dependent variable Characteristics (X’s) are the independent variables
Statistical approach Foreclosure is a “dichotomous” or “indicator” variable Y = 1 if foreclosure occurs and 0 otherwise Estimation yields probability of foreclosure
Foreclosure study: Laderman & Reid, Federal Reserve Bank of San Francisco
X’s can be dichotomous, categorical or continuous
Income, credit score, race
Fixed rate, loan-to-value ratio, prepay penalty, required documentation.
CRA regulated, in CRA assessment area, retail vs. wholesale
Income, % owner occupied, age of housing stock, capitalization (rent vs. home price), prices
Background Methods Findings Policy
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Low-Income Moderate-Income Middle-Income Upper-Income
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CRA Lenders Independent Mortgage Companies
• IMCs have higher foreclosure rates
Background Methods Findings Policy
Neighborhood Level Loan Characteristics
Low-income 1.73 *** Higher-priced 3.05 ***
Moderate-income 1.28 *** Fixed interest rate 0.35 ***
Middle-income 1.18 *** LTV 3.02 ***
Percent owner-occupied 1.00 *** Prepayment penalty 1.31 ***
Median year built 1.01 *** Full documentation 0.63 ***
Capitalization rate .753 Monthly payment 1.05 ***
House price appreciation 1.22 *** Borrower Characteristics Lender Characteristics
African American 1.79 *** CRA in assessment area .532 ***
Latino 1.36 *** CRA outside assessment area .874 ***
Asian 1.29 ***
Income 1.00 **
Low FICO score 4.07 ***
Mid-range FICO score 2.65 ***
• Model Results I (dependent variable: foreclosure)
Background Methods Findings Policy
Neighborhood Level Loan Characteristics
Low-income 1.73 *** Higher-priced 3.05 ***
Moderate-income 1.28 *** Fixed interest rate 0.35 ***
Middle-income 1.18 *** LTV 3.02 ***
Percent owner-occupied 1.00 *** Prepayment penalty 1.31 ***
Median year built 1.01 *** Full documentation 0.63 ***
Capitalization rate .753 Monthly payment 1.05 ***
House price appreciation 1.22 *** Borrower Characteristics Lender Characteristics
African American 1.79 *** CRA in assessment area .532 ***
Latino 1.36 *** CRA outside assessment area .874 ***
Asian 1.29 ***
Income 1.00 **
Low FICO score 4.07 ***
Mid-range FICO score 2.65 ***
• Model Results I (dependent variable: foreclosure)
Background Methods Findings Policy
Neighborhood Level Loan Characteristics
Low-income 1.73 *** Higher-priced 3.05 ***
Moderate-income 1.28 *** Fixed interest rate 0.35 ***
Middle-income 1.18 *** LTV 3.02 ***
Percent owner-occupied 1.00 *** Prepayment penalty 1.31 ***
Median year built 1.01 *** Full documentation 0.63 ***
Capitalization rate .753 Monthly payment 1.05 ***
House price appreciation 1.22 *** Borrower Characteristics Lender Characteristics
African American 1.79 *** CRA in assessment area .532 ***
Latino 1.36 *** CRA outside assessment area .874 ***
Asian 1.29 ***
Income 1.00 **
Low FICO score 4.07 ***
Mid-range FICO score 2.65 ***
• Model Results I (dependent variable: foreclosure)
Background Methods Findings Policy
Neighborhood Level Loan Characteristics
Low-income 1.73 *** Higher-priced 3.05 ***
Moderate-income 1.28 *** Fixed interest rate 0.35 ***
Middle-income 1.18 *** LTV 3.02 ***
Percent owner-occupied 1.00 *** Prepayment penalty 1.31 ***
Median year built 1.01 *** Full documentation 0.63 ***
Capitalization rate .753 Monthly payment 1.05 ***
House price appreciation 1.22 *** Borrower Characteristics Lender Characteristics
African American 1.79 *** CRA in assessment area .532 ***
Latino 1.36 *** CRA outside assessment area .874 ***
Asian 1.29 ***
Income 1.00 **
Low FICO score 4.07 ***
Mid-range FICO score 2.65 ***
• Model Results I (dependent variable: foreclosure)
Background Methods Findings Policy
Neighborhood Level Loan Characteristics
Low-income 1.73 *** Higher-priced 3.05 ***
Moderate-income 1.28 *** Fixed interest rate 0.35 ***
Middle-income 1.18 *** LTV 3.02 ***
Percent owner-occupied 1.00 *** Prepayment penalty 1.31 ***
Median year built 1.01 *** Full documentation 0.63 ***
Capitalization rate .753 Monthly payment 1.05 ***
House price appreciation 1.22 *** Borrower Characteristics Lender Characteristics
African American 1.79 *** CRA in assessment area .532 ***
Latino 1.36 *** CRA outside assessment area .874 ***
Asian 1.29 ***
Income 1.00 **
Low FICO score 4.07 ***
Mid-range FICO score 2.65 ***
• Model Results I (dependent variable: foreclosure)
Background Methods Findings Policy
• Model Results incl. origination channel (dependent variable: foreclosure) Neighborhood Level Loan Characteristics
Low-income 2.11 *** Higher-priced 2.47 ***
Moderate-income 1.35 *** Fixed interest rate 0.39 ***
Middle-income 1.24 *** LTV 2.53 ***
Percent owner-occupied 1.00 *** Prepayment penalty 1.55 ***
Median year built 1.01 *** Full documentation 0.63 ***
Capitalization rate .860 Monthly payment 1.05 ***
House price appreciation 1.20 *** Borrower Characteristics Lender Characteristics
African American 1.77 *** CRA in assessment area .743 ***
Latino 1.38 *** CRA outside assessment area .995
Asian 1.24 *** Correspondent loan 1.45 ***
Income 1.00 Wholesale/Broker loan 2.03 ***
Low FICO score 4.58 ***
Mid-range FICO score 2.73 ***
Background Methods Findings Policy
• Model 2: Results stratified by neighborhood income (dependent variable: foreclosure)
Lender Characteristics
Low Moderate Middle Upper CRA in assessment area .732 ** .584 *** .559 *** .485 ***
CRA outside assessment area .946 .842 *** .920 ** .844 ***
Correspondent loan
Wholesale/Broker loan
Background Methods Findings Policy
• Model 2: Results stratified by neighborhood income (dependent variable: foreclosure)
Lender Characteristics
Low Moderate Middle Upper CRA in assessment area .890 .960 .799 *** .640 ***
CRA outside assessment area .863 1.17 1.06 .927
Correspondent loan 1.58 1.62 *** 1.39 *** 1.37 ***
Wholesale/Broker loan 2.79 *** 1.96 *** 1.97 *** 2.12 ***
Foreclosure study conclusion
Note that retail presence in the neighborhood is important
“… one of the more interesting findings of our research is the evidence that some aspect of “local” presence seems to matter in predicting the sustainability of a loan.
Once a lender is removed from the community…or from the origination decision (wholesale loan)…foreclosure increase significantly.”
How does this relate to our study of asymmetric information? The empirical
evidence suggests that the informationgathered by local lenders and reduces moral hazard & adverse selection.
Conflict of Interest Rating agencies
Government delegates task of rating bond quality Government is principal, Rating agency is agent
Bond issuer pays rating agency
Note: principal-agent issues arise in regulation Who is the principal and who is the agent?
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