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Working Paper
Can Leverage Constraints Help Investors?
This paper provides causal evidence that leverage constraints can reduce the underperformance of individual investors. In accordance with Dodd-Frank, the CFTC was given regulatory authority over the retail market for foreign exchange and capped the maximum permissible leverage available to U.S. traders. By comparing U.S. traders on the same brokerages with their unregulated European counterparts, I show that the leverage constraint reduces average per-trade losses even after adjusting for risk. Since this causal approach holds constant contemporaneous market factors, these findings challenge the concept that individuals are better off when they are unconstrained in their risk-taking.
AUTHORS: Heimer, Rawley
DATE: 2014-12-03

Working Paper
Where the Wild Things Are: Measuring Systemic Risk through Investor Sentiment
In this paper, I develop a systemic risk measure derived from investor sentiment that has predictive power over future economic activity and market returns. Unlike existing measures, it is not focused on flagging investors? heightened awareness of risk at the end of a boom episode but rather on capturing shifts in their trading behavior at the beginning of the episode. The method allows investors and regulators to observe industries in which risks could be building and provides regulators some lead time in deploying their macroprudential tools.
AUTHORS: Ergungor, O. Emre
DATE: 2016-02-19

Working Paper
Macroprudential Policy: Results from a Tabletop Exercise
This paper presents a tabletop exercise designed to analyze macroprudential policy. Several senior Federal Reserve officials were presented with a hypothetical economy as of 2020:Q2 in which commercial real estate and nonfinancial debt valuations were very high. After analyzing the economy and discussing the use of monetary and macroprudential policy tools, participants were then presented with a hypothetical negative shock to commercial real estate valuations that occurred in the second half of 2020. Participants then discussed the use of the tools during an incipient downturn. Some of the findings of the exercise were that during an asset boom, there were limits to the effectiveness of US macroprudential tools in controlling narrow risks and that changes to the fed funds rate may not always simultaneously meet macroeconomic and financial stability goals. Some other findings were that during a downturn, it would be desirable to use high-frequency indicators for deciding when to release the countercyclical capital buffer (CCyB) and that tensions exist between microprudential and macroprudential goals when using the CCyB and the stress test.
AUTHORS: Rosen, Richard J.; Zlate, Andrei; Musatov, Alex; Vardoulakis, Alexandros; Prescott, Edward Simpson; Duffy, Denise; Tallarini, Thomas D.; Kovner, Anna; Yang, Emily; Haubrich, Joseph G.
DATE: 2019-05-21

Working Paper
Evaluating the Information Value for Measures of Systemic Conditions
Timely identification of coincident systemic conditions and forward-looking capacity to anticipate adverse developments are critical for macroprudential policy. Despite clear recognition of these factors in literature, an evaluation methodology and empirical tests for the information value of coincident measures are lacking. This paper provides a twofold contribution to the literature: (i) a general-purpose evaluation framework for assessing information value for measures of systemic conditions, and (ii) an empirical assessment of the information value for several alternative measures of US systemic conditions. We find substantial differences among the measures, of which the Cleveland Financial Stress Index shows best-in-class identification performance. In terms of forecasting performance, Kamakura?s Troubled Company Index, Cleveland Financial Stress Index, and Goldman Sachs Financial Conditions Index show moderately stable usefulness metrics over time.
AUTHORS: Gramlich, Dieter; Oet, Mikhail V.; Ong, Stephen J.; Dooley, John; Sarlin, Peter
DATE: 2015-08-06

Report
Uncovering covered interest parity: the role of bank regulation and monetary policy
We analyze the factors underlying the recent deviations from covered interest parity. We show that these deviations can be explained by tighter post-crisis bank capital regulations that made the provision of foreign exchange swaps more costly. Moreover, the recent monetary policy and related interest rate divergence between the United States and other major foreign countries has led to a surge in demand for swapping low interest rate currencies into the U.S. dollar. Given the higher bank balance sheet costs resulting from these regulatory changes, the increased demand for U.S. dollars in the swap market could not be supplied at a constant price, thereby amplifying violations of covered interest parity. Furthermore, we show that dollar swap line agreements existing between the Federal Reserve and foreign central banks mitigate pressure in the swap market. However, the current conditions that govern the provision of dollar funding through foreign central banks are not favorable enough to reduce deviations from covered interest parity to zero.
AUTHORS: Puria, Kovid; Bräuning, Falk
DATE: 2017-06-01

Report
Technology, the nature of information, and fintech marketplace lending
The retail lending landscape has changed considerably over the past two decades, the most recent example being the rapid growth of online, or FinTech, lending to consumers and small businesses. This paper discusses how the boundary of the firm in the retail lending market is affected by advances in information technology that have turned what was previously soft information on borrower credit risk into encoded hard data that can be precisely transmitted across firms at a very low cost. The ability to collect and process information has become the critical resource for lending decisions, enabling entities with an advantage in producing information, such as technology firms, to compete in traditional retail lending activities. Efficiency can also be gained by relying more on hard data and firm specialization in a credit supply chain. Whether these changes favor hierarchical large banks or small start-up firms depends on their relative funding cost. In the aftermath of the financial crisis, an increase in banks? capital costs due to enhanced regulation is likely an important factor behind the faster growth of the new FinTech entrants. The need for funding to make loans means that the socially desirable objective of avoiding excessive credit contraction during economic downturns is better served in the current system by traditional banks, owing to their access to deposit insurance and the liquidity provided by the Federal Reserve. In sum, for the foreseeable future, banks will coexist as well as partner with FinTech lenders in the retail lending market. Banks? market share in loans to consumers and small businesses will likely fluctuate countercyclically.
AUTHORS: Wang, J. Christina
DATE: 2018-10-01

Working Paper
Unconventional monetary policy and the behavior of shorts
In November 2008, the Federal Reserve announced the first of a series of unconventional monetary policies, which would include asset purchases and forward guidance, to reduce long-term interest rates. We investigate the behavior of shorts, considered sophisticated investors, before and after a set of these unconventional monetary policy announcements that spot bond markets did not fully anticipate. Short interest in agency securities systematically predicts bond price changes and other asset returns on the days of monetary announcements, particularly when growth or monetary news is released, indicating shorts correctly anticipated these surprises. Shorts also systematically adjusted their positions after announcements in the direction of the announcement surprise when the announcement released growth news, suggesting that shorts interpreted monetary events to imply further yield changes in the same direction.
AUTHORS: McInish, Thomas; Neely, Christopher J.; Planchon, Jade
DATE: 2017-10-27

Working Paper
Using bankruptcy to reduce foreclosures: does strip-down of mortgages affect the supply of mortgage credit?
We assess the credit market impact of mortgage ?strip-down? ? reducing the principal of underwater residential mortgages to the current market value of the property for homeowners in Chapter 7 or Chapter 13 bankruptcy. Strip-down of mortgages in bankruptcy was proposed as a means of reducing foreclosures during the recent mortgage crisis but was blocked by lenders. Our goal is to determine whether allowing bankruptcy judges to modify mortgages would have a large adverse impact on new mortgage applicants. Our identification is provided by a series of U.S. Court of Appeals decisions during the late 1980s and early 1990s that introduced mortgage strip-down under both bankruptcy chapters in parts of the U.S., followed by two Supreme Court rulings that abolished it throughout the U.S. We find that the Supreme Court decision to abolish mortgage strip-down under Chapter 13 led to a reduction of 3% in mortgage interest rates and an increase of 1% in mortgage approval rates, while the Supreme Court decision to abolish strip-down under Chapter 7 led to a reduction of 2% in approval rates and no change in interest rates. We also find that markets react less to circuit court decisions than to Supreme Court decisions. Overall, our results suggest that lenders respond to forced renegotiation of contracts in bankruptcy, but their responses are small and not always in the predicted direction. The lack of systematic patterns evident in our results suggests that introducing mortgage strip-down under either bankruptcy chapter would not have strong adverse effects on mortgage loan terms and could be a useful new policy tool to reduce foreclosures when future housing bubbles burst.
AUTHORS: White, Michelle J.; Tewari, Ishani; Li, Wenli
DATE: 2014-12-01

Working Paper
Debt Collection Agencies and the Supply of Consumer Credit
This paper ﬁnds that stricter laws regulating third-party debt collection reduce the number of third-party debt collectors, lower the recovery rates on delinquent credit card loans, and lead to a modest decrease in the openings of new revolving lines of credit. Further, stricter third-party debt collection laws are associated with fewer consumer lawsuits against third-party debt collectors but not with a reduction in the overall number of consumer complaints. Overall, stricter third-party debt collection laws appear to restrict access to new revolving credit but have an ambiguous eﬀect on the nonpecuniary costs that the debt collection process imposes on borrowers.
AUTHORS: Fedaseyeu, Viktar
DATE: 2020-02-12

Working Paper
Mortgage Loss Severities: What Keeps Them So High?
Mortgage loss-given-default (LGD) increased significantly when house prices plummeted and delinquencies rose during the financial crisis, but it has remained over 40 percent in recent years despite a strong housing recovery. Our results indicate that the sustained high LGDs post-crisis are due to a combination of an overhang of crisis-era foreclosures and prolonged foreclosure timelines, which have offset higher sales recoveries. Simulations show that cutting foreclosure timelines by one year would cause LGD to decrease by 5?8 percentage points, depending on the trade-off between lower liquidation expenses and lower sales recoveries. Using difference-in-differences tests, we also find that recent consumer protection programs have extended foreclosure timelines and increased loss severities in spite of their benefits of increasing loan modifications and enhancing consumer protections.
AUTHORS: An, Xudong; Cordell, Lawrence R.
DATE: 2019-03-19

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