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Working Paper
Predatory mortgage lending
Regulators express growing concern over predatory loans, which we take to mean loans that borrowers should decline. Using a model of consumer credit in which such lending is possible, we identify the circumstances in which it arises both with and without competition. We find that predatory lending is associated with highly collateralized loans, inefficient refinancing of subprime loans, lending without due regard to ability to pay, prepayment penalties, balloon payments, and poorly informed borrowers. Under most circumstances competition among lenders attenuates predatory lending. We use our ...
Working Paper
Market run-ups, market freezes, inventories, and leverage
This paper supersedes Working Paper No. 12-8.> We study trade between an informed seller and an uninformed buyer who have existing inventories of assets similar to those being traded. We show that these inventories may lead to prices that increase even absent changes in fundamentals (a .run-up.), but may also make trade impossible (a .freeze.) and hamper information dissemination. Competition may amplify the run-up by inducing buyers to enter loss-making trades at high prices to prevent a competitor from purchasing at a lower price and releasing bad news about inventory values. Inventories ...
Working Paper
Market run-ups, market freezes, and leverage
The authors study trade between a buyer and a seller when both may have existing inventories of assets similar to those being traded. They analyze how these inventories affect trade, information dissemination, and price formation. The authors show that when the buyer's and seller's initial leverage is moderate, inventories increase price and trade volume, but when leverage is high, trade may become impossible (a "market freeze"). Their analysis predicts a pattern of trade in which prices and trade volume first increase, and then markets break down. The authors use their model to discuss ...
Working Paper
Predatory lending in rational world
Regulators express growing concern over ?predatory lending,? which we take to mean lending that reduces the expected utility of borrowers. We present a rational model of consumer credit in which such lending is possible, and identify the circumstances in which it arises with and without competition. Predatory lending is associated with imperfect competition, highly collateralized loans, and poorly informed borrowers. Under most circumstances competition among lenders eliminates predatory lending.
Working Paper
Does junior inherit? Refinancing and the blocking power of second mortgages
Refinancing a first mortgage puts legal principles in conflict when other, junior, liens also exist. On one hand, the principle that seniority follows time priority leaves the new refinancing mortgage junior to mortgages that were junior to the original, refinanced first mortgage. On the other hand, the principle of equitable subrogation gives the refinancing mortgage the seniority of the claim it paid down. States resolve this tension differently, thus differentiating how much a second mortgage impedes refinancing of the first. We exploit this cross-state variation to identify the impact on ...
Journal Article
Small business finance in two Chicago minority neighborhoods
The authors use survey data to measure the use of formal and informal sources of financing by owners of small businesses in two ethnic neighborhoods. The authors find substantial differences across ethnic groups in the amount of start-up funding obtained and in the use of trade credit.
Working Paper
Why do markets freeze?
Consider the sale of mortgages by a loan originator to a buyer. As widely noted, such a transaction is subject to a severe adverse selection problem: the originator has a natural information advantage and will attempt to sell only the worst mortgages. However, a second important feature of this transaction has received much less attention: both the seller and the buyer may have existing inventories of mortgages similar to those being sold. The authors analyze how the presence of such inventories affects trade. They use their model to discuss implications for regulatory intervention in ...
Working Paper
Market-based regulation and the informational content of prices
Various laws and policy proposals call for regulators to make use of the information reflected in market prices. We focus on a leading example of such a proposal, namely that bank supervision should make use of the market prices of traded bank securities. We study the theoretical underpinnings of this proposal in light of a key problem: if the regulator uses market prices, prices adjust to reflect this use and potentially become less revealing. We show that the feasibility of this proposal depends critically on the information gap between the market and the regulator. Thus, there is a strong ...
Journal Article
Formal and informal financing in a Chicago neighborhood
This article documents not only the actual use of banks, but also the widespread use of alternative financing mechanisms, using data from a survey of households and businesses in a Hispanic neighborhood of Chicago.