(previously titled: The Effect of Dealer Leverage on Mortgage Quality)
Journal of Financial Economics, 149, 451-472
AEA 2022: Poster Presentation
Securities dealers receive mortgages as collateral for credit lines provided to mortgage companies and reuse the same collateral to borrow money. Exploiting the 2005 BAPCPA rule change, which granted mortgage collateral preferred bankruptcy treatment, I find that strengthening creditor rights increases dealers' collateral reuse. Increasing collateral reuse creates a money multiplier that increases credit supply. Using a novel dataset linking dealers to the mortgage companies they fund reveals that post-BAPCPA, dealers supply additional credit to mortgage companies by increasing credit lines and relaxing restrictions on collateral securing them. In response, mortgage companies increase origination volume and shift into riskier products.
This paper establishes that high income-volatility, minority borrowers were disproportionately exposed to the expansion of credit following the BAPCPA 2005 policy that granted preferred bankruptcy status to mortgage backed collateral in the sale and repurchase market. To show this, I generate a model of mortgage lending where a lender lends in two markets: one for conforming mortgages and one for alternative mortgages. The model assumes that alternative mortgage products are optimal for borrowers with higher income variability. When the collateral value of alternative mortgages increases, it decreases lenders’ cost of capital, leading them to decrease the price that they charge. If the price falls below the borrowers’ reservation price, lending expands in this market. I interpret BAPCPA 2005 as an increase in collateral value of alternative mortgages. Consistent with the model, the paper documents that BAPCPA caused the sudden and disproportionate expansion of alternative mortgage products among high-income-variability minority-dominant zip codes leading up to the Global Financial Crisis, and disproportionately increased defaults in these areas during the crisis.
WORK IN PROGRESS
In this paper, I study the effects of bank leverage ratio restrictions in a general equilibrium model of the macroeconomy where lenders can anticipate bank runs. This framework allows the analysis of the tradeoffs associated with bank capital requirements – while unlimited leverage allows capital to flow most freely to its most efficient users, limiting leverage through capital requirements reduces the probability of a bank run. This model enables me to study the general equilibrium effects of these tradeoffs on household welfare to understand characteristics of the optimal bank leverage ratio requirement. I find that the optimal leverage restriction will be time varying across the business cycle. When the household’s marginal utility of consumption is highest, the leverage ratio requirement should be the least restrictive. Conversely, when the household’s marginal utility approaches its steady state level, the optimal leverage ratio becomes more restrictive.