Essays on Financial Intermediation

Lewis, Brittany Almquist

doi:https://doi.org/10.21985/n2-wfmy-4z07

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Essays on Financial Intermediation

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This dissertation contains three chapters. In Chapter 1, 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. In Chapter 2, I explore how strengthening creditor rights on collateral used in large short-term funding markets, known as the sale and repurchase markets (the “repo” markets), both generates a credit supply shock and deteriorates the quality of the assets underlying the collateral. I study a policy change in 2005 that strengthened creditor rights on mortgage-backed repo collateral. I present evidence that these stronger creditor rights relaxed large securities dealers’ cost of funding. To study how dealers passed the resulting increased supply of credit on to the mortgage companies that they funded, I hand-collect data on credit lines linking dealers to mortgage companies. Using an across dealer, within mortgage company difference-in-differences analysis, I find that in response to the policy change, dealers increased their funding to mortgage companies. I also find evidence that dealers systematically relaxed restrictions on the mortgage products that they funded. In Chapter 3, I use a county-level difference-in-differences analysis to estimate that the expansion in credit led to a 9% increase in mortgage lending volume and increased originations of the riskiest mortgage products. I estimate that mortgages originated in response to the policy change made up 38% of mortgage defaults among all mortgages originated during 2005-2006. This chapter provides evidence that the increase in dealer funding to mortgage companies post shock amplified both the “last gasp” of the housing boom and the severity of the home price decline in the Financial Crisis.

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