During the economic crisis, we saw an interesting pattern of activity among commercial banks. As prices of securities dramatically dropped, banks purchased the securities, looking to make profits when the prices later increased. This had an effect on lending, as banks used their capital to buy securities rather than make loans. This despite the banks taking billions at the time from the Federal Reserve in liquidity support.
Now, regulators around the world are debating whether banks should be allowed to trade in securities. In the U.S. we have the Volcker rule, which prevents banks from proprietary trading. In Europe, they have the Liikanen Report. But an important question in these discussions is what are the benefits and costs to not having banks trade securities?
Answering that question has been difficult due to a lack of comprehensive micro data at the security level on banks’ trading activities. However, in a recent study, my colleagues and I were given access to a unique, proprietary dataset from the Bundesbank (the German central bank) that provides information on security-level holdings for all banks in Germany at a quarterly frequency for the period between 2005 and 2012.
So we were able to analyze whether, during a financial crisis, banks with higher trading expertise increase their investments in securities, especially in securities that had a larger price drop, to profit from the trading opportunities. Further, we examined how this impacts lending.
With regard to financial reform, the outcome of the November election seems straightforward. At the presidential level, the too-big-to-fail banks bet heavily on Mitt Romney and lost; President Obama received relatively few contributions from the financial sector, in contrast to 2008. In Senate races, Elizabeth Warren of Massachusetts and Sherrod Brown of Ohio demonstrated that it was possible to win not just without Wall Street money but against Wall Street money. Read More »
When a bank considers a loan, it looks at the borrower’s income, assets, credit history, and plans for the money. On microloan websites, lenders have one other way to evaluate a borrower’s creditworthiness. They can observe the behavior of other lenders.
With a colleague, Peng Liu of Cornell University, I have been studying Prosper.com, the largest of the microlending sites. On Prosper, lending is transparent. Borrowers make requests in public postings and typically rely on multiple lenders. Prosper assigns credit ratings to borrowers, and friends of borrowers can post endorsements. Once the process is under way, lenders can see how other lenders respond to the listing.
We analyzed over 2 ½ years of Prosper data to determine the dynamics of lender behavior. We thought we might see what is known as “irrational herding,” or mimicking. If irrational herding is at work, then a listing that received a strong initial response would attract more and more lenders. As we sifted through the data, we found no evidence this was happening.
The numbers are staggering: The average family debt in Canada has increased 78 percent over the last two decades, recently hitting $100,000 per family. In the third quarter of 2010, Canadians’ debt-to-disposable income ratio surpassed the US for the first time since the late 1990s. In my home country – I grew up just outside of Ottawa, Ontario – this is getting a lot of publicity (comparing ourselves to our American cousins is always a popular pastime).