FREE ELECTRONIC LIBRARY - Dissertations, online materials

Pages:   || 2 | 3 | 4 | 5 |

«Elena Loutskina University of Virginia, Darden School of Business & Philip E. Strahan Boston College, Wharton Financial Institutions Center & NBER ...»

-- [ Page 1 ] --


Elena Loutskina

University of Virginia, Darden School of Business


Philip E. Strahan

Boston College, Wharton Financial Institutions Center & NBER

March 2012


The Financial Crisis and the Great Recession illustrate the sensitivity of the economy to a

housing bust. This paper shows that financial integration, fostered by deregulation allowing

banks to form nationwide branch networks, amplified housing-price volatility and increased the economy’s sensitivity to local housing-price shocks. We exploit variation in credit-supply subsidies across local markets from the Government-Sponsored Enterprises to measure housing price changes unrelated to fundamentals. Using this instrument, we find that a 1% rise in housing prices causes a 0.25% increase in economic growth. This effect is larger in localities more financially integrated with other markets through bank ownership ties. Financial integration thus raised the effect of collateral shocks on the economy, thereby increasing economic volatility.



The recent ‘Great Recession’, many argue, had its origins in the boom and bust in housing, and the knock-on effects of the resulting financial crisis (Brunnermeier, 2008). Some argue that the length and depth of this recession stems from the slow recovery of housing and the associated debt overhang for consumers (Mian and Sufi, 2011). In this paper, we study links from housing to the overall economy in the years leading up to the crash (1994 to 2006). During this period, local housing prices became more volatile as regions such as the Sun Belt experienced dramatic booms. Figure 1 plots the mean absolute growth shock of local housing prices from 1975 to 2006. Volatility trends down during the 1970s and 1980s. Starting in the 1990s, however, volatility stops falling and then begins to rise. This trend break coincides with changes in the financial and banking systems in the US, which have become increasingly well integrated as deregulation allowed banks to form nationwide branch networks and as securitization allowed mortgage credit to flow easily across markets. We show that shocks to local housing demand were amplified by financial integration because capital could flow freely across connected markets. Financial integration also strengthened the link from housing to the overall economy.

Financial integration may dampen or amplify economic shocks. Morgan, Rime and Strahan (2004) – MRS hereafter – show theoretically that integration’s effect on volatility depends on the sources and magnitudes of shocks hitting the local economy. With integration, local economies become more insulated from shocks to the supply of local finance (e.g. local bank capital). During the 1980s and early 1990s, these shocks were a major source of businesscycle instability (Bernanke and Lown, 1991). For example, the number of bank and S&L failures during the 1980s averages more than 150 per year (Kroszner and Strahan, 2008), and the

–  –  –

Integration makes local economies less sensitive to these financial disturbances because capital can flow in from external sources and thus allow investment to continue, even if local lenders are distressed. MRS show empirically that state-level banking integration fostered by deregulation during the 1970s and 80s lowered volatility of local economies in these years.

MRS’s theoretical model, however, also shows that integration, by allowing financial capital to flow away from depressed areas and into booming ones, can amplify local cycles. For example, if collateral values rise sharply in a locality, borrower debt capacity and demand for credit increases; integration helps bring financial resources from abroad to satisfy higher credit demand. The influx of credit from external sources raises growth above what would have been possible in a stand-alone, or dis-integrated, financial system. These flows correspondingly reduce collateral values from areas with relatively weak credit demand because these market face capital outflows. Thus, capital flows generated by credit demand shocks will reduce comovements in collateral values across financially integrated markets.

Beyond its effects on capital flows, integration is also associated with lower investment by lenders in private information about local business conditions, borrower credit quality and housing-price fundamentals (Loutskina and Strahan, 2011; Romero-Cortes, 2011). As a result of securitization, for example, residential mortgage credit supply responds more now to changes in the market value of collateral than in the past because lenders condition their credit decisions more on public signals (e.g. borrower FICO scores and loan-to-value ratios) and less on private information (Rajan, Seru and Vig, 2010). Both of these forces – more ‘flighty’ capital and more reliance on public information – may increase collateral volatility and raise the sensitivity of local cycles to variation in collateral values. Consistent with these ideas, we find that financial

–  –  –

sector have a quantitatively substantial causal impact on local economies, and that the transmission of these housing-price shocks increases with financial integration.

The analysis proceeds in three steps. First, we document a positive relationship between financial integration and the magnitude of local house-price shocks. To do so, we measure financial integration at the level of the Central Business Statistical Area (CBSA), the US Census Bureau’s definition of a city. The measure (In-CBSA ratio) is based on the ownership of bank branches across CBSAs, equal to the fraction of local deposits owned by a banking company also owning branches in other CBSA markets. So, a CBSA in which all of its branches are owned by banks with branches in other CBSAs would have In-CBSA ratio = 100%.

We find that the volatility of shocks to CBSA-level housing price growth increases with financial integration. The effect increases in magnitude when we use variation across states in restrictions on interstate branching as an instrument for financial integration (Rice and Strahan, 2010). Thus, there is a robust difference in local house-price volatility between more- and lessintegrated local markets. This result reverses that of MRS, who use data from the 1970s and 1980s, when shocks to the financial sector were an important source of business-cycle variation.1 Our results, however, are consistent with the theoretical argument that, in the absence of shocks to financial institutions, integration amplifies the impact of collateral shocks. To test this mechanism, we compare shocks for all unique pairs of local markets. If integration increases capital flightiness in response to collateral values shocks, then integration between pairs of markets ought to reduce the correlation between shocks across markets. Using housing price


1 Like MRS, we have also tested whether the amount of deposits in external markets, as a second integration measure, affects volatility. This second integration measure is also positively related to volatility in some specifications, although its magnitude is smaller and less significant than our primary integration measure.

–  –  –

with each other have less similar changes in housing prices, controlling for trends (time dummies), for pair-wise fixed effects and for the similarity of industry composition. Again, we find that the effects increase in magnitude when we instrument for integration using a pair-wise combination of each area’s regulatory stance toward interstate branching.2 In the second part of the analysis, we build an instrument for house-price appreciation that exploits the importance of the Government-Sponsored Enterprises (GSEs) – Fannie Mae and Freddie Mac – in housing finance. Fannie and Freddie subsidize mortgage credit, but only for mortgages that fall below the jumbo-loan threshold (Loutskina and Strahan, 2009). Borrowers with housing demand near the jumbo-loan threshold stand to benefit from an increase in the threshold, leading to an increase in housing demand and housing prices (Adelino, Schoar and Severino, 2011). While the jumbo-loan cutoff changes uniformly across CBSAs, its effects vary across markets. For example, in Los Angeles - where about 5.3% of mortgages were made to borrowers within 5% of the jumbo-loan cutoff - the change in cut-off would have a bigger impact than in Wichita, Kansas - where this fraction was about 0.5%. Since there is both crosssectional and time-series variation in the amount of such demand (e.g. LA v. Wichita), we generate a set of instruments based on the product of the sensitivity to changes in the jumbo-loan cutoff in market i during year t-1 times the change in the cutoff itself between years t-1 and t.

The instruments depend only on the distribution of mortgage credit during the preceding year and the change in the jumbo-loan cutoff during the current year, which is the same across all local markets and depends mechanically on lags of increases in nationwide prices. Furthermore, we exploit the elasticity of the housing supply across different geographies to better capture the


2 Kalemni, Papaionnou and Peydro (2010) find similar effects following financial integration across 20 developed economies.

–  –  –

that these instruments pick up variation in changes in housing demand exogenous to overall economic fundamental in the local area.

We find that these instruments are powerful. Local housing prices appreciate faster in markets where credit on jumbo borrowers was more constrained in the prior year, based on the distribution of borrowers around the jumbo cutoff. This effect is stronger in markets with relatively inelastic housing supply because prices are more sensitive to changes in demand where the physical supply of housing is limited by geographic barriers.

Armed with exogenous variation in housing prices, the third part of the analysis shows that housing prices have a strong causal impact on local economic growth in employment and output. In our base model, a 1% increase in housing prices causes an increase in local GDP growth of about 0.25% and an increase in non-construction, non-finance employment growth of about 0.15%. The latter effect implies that higher prices spill over to sectors not directly affected by housing. We then show that the effects of house-price shocks are stronger in local markets with high levels of financial integration than in markets with low integration. In local areas onestandard deviation above the mean level of financial integration, a 1% housing price shock leads to a 0.30% increase in GDP growth. Taken together – higher housing price volatility and increased sensitivity to house-price shocks – the results imply that financial integration has increased economic volatility, both by amplifying variation in collateral values (house prices) and by strengthening links from collateral to the overall economy.

Our paper contributes to three strands of the literature. First, the effect of financial integration on economic volatility has been explored both across US states and also in the

–  –  –

Demyanyk, Ostergaard and Sorenson, 2007; Kalemni, Papaionnou and Peydro (2010)). We find that integration can amplify shocks and de-sychronize asset markets in an environment of strong credit demand and a profitable financial sector. In other settings, where financial shocks are important, integration can increase synchronization because credit supply shocks propagate across connected markets (e.g. Peek and Rosengren, 2000). Second, conventional explanations for the US housing boom blame loose lending practices as a key driver of price appreciation (e.g., Mian and Sufi (2009), Keys et al (2010), Demyanyk and Van Hemert (2010), Loutskina and Strahan (2011)). Yet these studies do little to explain why booms were concentrated in places like as Florida, Arizona and California. Financial integration can rationalize regional booms by allowing capital to flow into areas with strong credit demand.

Third, many have argued that the so-called ‘Great Recession’ has its root in the crash of housing prices beginning in the middle of 2006. Our results are consistent with this explanation but also suggest that the economic boom was itself fueled by house-price appreciation. The findings extend the work of Mian and Sufi (2009 and 2011), who show that household debt and consumption were strongly correlated with house-price appreciation during the boom.

Conversely, declines in consumer spending and financial distress across local markets during the bust are also associated with declines in housing equity. Unlike Mian and Sufi (2011), however, we go a step further and estimate the total effect of housing price shocks on the economy, and we condition this estimate on aspects of the financial system. Shocks to housing have had a large effect on the overall economy, especially in markets that are well integrated nationally.

In the next section we briefly review the forces leading to increased integration over time.

In Section III, we describe our integration measures in detail, and document their link to local

–  –  –

growth. Here, we first establish a first-stage model that relates changes in credit-supply subsidies from the GSEs to house-price appreciation. We then use this model to generate an instrument for housing price changes to estimate its causal impact on the economy as a whole.

Section V concludes.


Pages:   || 2 | 3 | 4 | 5 |

Similar works:

«Theoretical Corporate Finance References Professor Michael R. Roberts Organization Corporate finance is a large, ever-growing, and ever-changing field. Consequently, it is virtually impossible to organize corporate finance into clear or widely agreed upon categories that can be studied independently or sequentially. Nonetheless, a number of “literatures” have developed within corporate finance to help with this classification. This classification may not result in the most elegant or even...»

«Table of Contents Articles Role of Microcredit for Poverty alleviation in Pakistan: A Case Study of Punjab Rural Support Programme Nadia Asghar, Muhammad Waqas Chughtai, Bashir Ahmad Khilji Cloud Technology and Business Strategies Li Zhong Zhang Production and Marketing of Fresh Mangoes in Krishnagiri District of Tamil Nadu Samsai Thangarasu SETTING UP OF A JOINT VENTURE BETWEEN PHARMA AND BIOTECH COMPANIESA STUDY Ajay Kumar T R FISCAL FEDERAL SYSTEM IN INDIA ADDAI BIDDIKI, Santosh Ranganath...»

«A QUANTITATIVE CORRELATIONAL STUDY OF TAA WORKER RETRAINING PROGRAMS, WORKER CHARACTERISTICS, AND WORKER CAREER OUTCOMES By John A. Boutwell Jr. A Dissertation Presented in Partial Fulfillment of the Requirements for the Degree Doctor of Business Administration UNIVERSITY OF PHOENIX JULY 28, 2008 UMI Number: 3353747 INFORMATION TO USERS The quality of this reproduction is dependent upon the quality of the copy submitted. Broken or indistinct print, colored or poor quality illustrations and...»

«What do new forms of finance mean for EM central banks? An overview M S Mohanty 1 The size and the structure of financial intermediation influence the cost of credit, the risk exposure of financial institutions and the effectiveness with which monetary policy is transmitted to the economy. Over the past decade, financial intermediation in emerging market economies (EMEs) has undergone important changes: a higher volume of debt financing has gone hand in hand with a growing internationalisation...»

«ANNUAL MEETING MALTA 31 MAY 2 JUNE 2016 1 INTRODUCTION FROM THE GREF CHAIRMAN Jason Lane GREF Chairman Dear Friends and Colleagues, A warm welcome to the beautiful Island of Malta and a big thank you to Joseph Cuschieri and our colleagues at the MGA for hosting our Conference and Annual Business Meeting. GREF has been renewed and re-energised since revising and updating our constitution in 2012, becoming more dynamic, self-confident and relevant to our members. This year continues to build on...»

«Corporate Propaganda: Its Implications For Accounting And Accountability David J Collison Department of Accountancy and Business Finance, University of Dundee, Scotland, U.K. email d.j.collison@dundee.ac.uk Tel +44(0)1382 344857 Fax +44(0)1382 348421 Acknowledgements I would like to particularly thank (chronologically) Rob Gray, Lee Parker and George Frankfurter for their advice and encouragement in the development of this paper. I would also like to thank David Power, Lorna Stevenson, and...»

«Seagate Technology* A case (with teaching note) on the role of senior business leaders in driving work/life cultural change. Phyllis Siegel, Rutgers the State University of New Jersey The Wharton Work/Life Roundtable A Division of the Wharton Work/Life Integration Project University of Pennsylvania * This research was funded in part by a Sloan Foundation Grant #B1999-76. A note of special gratitude goes to: Alice Campbell, Scott Cooper, Debbie Hufnagel, and Ellen Ernst Kossek for their helpful...»

«Overview Part A: Strategic assessment Part B1: Business case – developing the business case Part B2: Business case – procurement options Part B3: Business case – funding and financing options Part C: Project development Part D: Tender process Part E: Contract management Part F: Project review Annexure 1: Reports to the Council Annexure 2: Sources of power for local government Annexure 3: Risk checklist Annexure 4: Gateway review process Annexure 5: Case studies Bibliography © Maddocks...»

«To the Ministry of Finance 15 January 2014 UNOFICIAL ENGLISH TRANSLATION Recommendation on the exclusion of PT Astra International Tbk from the Government Pension Fund Global's investment universe Contents 1 Summary 1 2 Introduction 2 2.1 What the Council has assessed 2 2.2 Sources 3 3 About Astra International and PT Astra Agro Lestari 4 4 The Council’s findings 4 4.1 The concessions in Kalimantan 5 4.1.1 Conversion of HCV areas 7 4.1.2 Overlap with habitats for threatened species 8 4.1.3...»

«CROSS-SECTOR Latin America SECTOR IN-DEPTH Global Headwinds Pressure Credit 2 SEPTEMBER 2015 Conditions in Region » Global macroeconomic headwinds will pressure Latin American credit conditions TABLE OF CONTENTS through 2016. Several factors together create an adverse external backdrop for Latin GLOBAL MACROECONOMIC 2 HEADWINDS WILL PRESSURE LATIN America: renewed expectations for muted global economic growth, China’s gradual AMERICAN CREDIT CONDITIONS slowdown, US monetary policy...»

«Reference number: IR-125/2014 25 April 2014 Resolutions made at OTP Bank’s AGM OTP Bank Plc. announces that at its Annual General Meeting of 25 April 2014 the following resolutions were made: 1/2014 The Annual General Meeting accepts the Board of Directors’ Business Report on 2013 business activities of the Company, as well as the proposal for the Bank’s separate – in accordance with Hungarian Accounting Standards – and consolidated financial statements – in accordance with...»

«Stagnation or Transformation in Indonesia? Olle Törnquist Indonesia is regularly hailed as a showcase ‘new democracy’—an all too rare democratic success story from the post-1970s Global South (e.g. Diamond 2010 and Horowitz 2013). Conditions there were far from ideal for the emergence of a liberal democratic regime. But despite a background of more than three decades of harsh dictatorship and even a massacre of leftists, endemic corruption, capitalist growth based the extraction of...»

<<  HOME   |    CONTACTS
2016 www.dissertation.xlibx.info - Dissertations, online materials

Materials of this site are available for review, all rights belong to their respective owners.
If you do not agree with the fact that your material is placed on this site, please, email us, we will within 1-2 business days delete him.