What explains high unemployment? The aggregate demand channel

A drop in aggregate demand driven by shocks to household balance sheets is responsible for a large fraction of the decline in U.S. employment from 2007 to 2009. The aggregate demand channel for unemployment predicts that employment losses in the non-tradable sector are higher in high leverage U.S. counties that were most severely impacted by the balance sheet shock, while losses in the tradable sector are distributed uniformly across all counties. We find exactly this pattern from 2007 to 2009. Alternative hypotheses for job losses based on uncertainty shocks or structural unemployment related to construction do not explain our results. Using the relation between non-tradable sector job losses and demand shocks and assuming Cobb-Douglas preferences over tradable and non-tradable goods, we quantify the effect of aggregate demand channel on total employment. Our estimates suggest that the decline in aggregate demand driven by household balance sheet shocks accounts for almost 4 million of the lost jobs from 2007 to 2009, or 65% of the lost jobs in our data.

Who Goes to College? Differential Enrollment by Race and Family Background

While trends in college enrollment for blacks and whites have been the subject of study for a number of years, little attention has been paid to the variation in college enrollment by socioeconomic status (SES). It is well documented that, controlling for family background, blacks are more likely to enroll in college than whites. This relationship is somewhat deceptive, however. Upon closer examination, we find that blacks are more likely to enroll in college than their white counterparts only among low-SES individuals. Among high SES individuals, this pattern is reversed. We also find that this relationship is strongest in the 1970s and appears to disappear over time; by the 1990s, blacks are no more likely to attend college than whites at any end of the SES distribution. This paper first documents this phenomenon and then attempts to understand what is driving these differences across the distribution of family background characteristics and why the relationship is changing over time. Although they have a significant impact on college enrollment behavior, tuition costs and local labor markets explain very little of racial differences in college entry. We do uncover different responses to tuition and labor markets by individuals from different ends of the SES distribution, an important consideration for policies targeted at improving college enrollment for low-SES individuals.

Dynamic Inefficiencies in Insurance Markets: Evidence from long-term care insurance

We examine whether unregulated, private insurance markets efficiently provide insurance against reclassification risk (the risk of becoming a bad risk and facing higher premiums). To do so, we examine the ex-post risk type of individuals who drop their long-term care insurance contracts relative to those who are continually insured. Consistent with dynamic inefficiencies, we find that individuals who drop coverage are of lower risk ex-post than individuals who were otherwise-equivalent at the time of purchase but who do not drop out of their contracts. These findings suggest that dynamic market failures in private insurance markets can preclude the efficient provision of insurance against reclassification risk.

Foreclosures, House Prices, and the Real Economy

States without a judicial requirement for foreclosures are twice as likely to foreclose on delinquent homeowners. Comparing zip codes close to state borders with differing foreclosure laws, we show that foreclosure propensity and housing inventory jump discretely as one enters non-judicial states. There is no jump in other homeowner attributes such as credit scores, income, or education levels. The increase in foreclosure rates in non-judicial states persists for at least five years. Using the judicial / non-judicial law as an instrument for foreclosures, we show that foreclosures lead to a large decline in house prices, residential investment, and consumer demand.

Resolving Debt Overhang: Political Constraints in the Aftermath of Financial Crises

Debtors bear the brunt of a decline in asset prices associated with financial crises and policies aimed at partial debt relief may be warranted to boost growth in the midst of crises. Drawing on the US experience during the Great Recession of 2008-09 and historical evidence in a large panel of countries, we explore why the political system may fail to deliver such policies. We find that during the Great Recession creditors were able to use the political system more effectively to protect their interests through bailouts. More generally we show that politically countries become more polarized and fractionalized following financial crises. This results in legislative stalemate, making it less likely that crises lead to meaningful macroeconomic reforms.

Fraudulent Income Overstatement on Mortgage Applications during the Credit Expansion of 2002 to 2005

Academic research, government inquiries, and press accounts show extensive mortgage fraud during the housing boom of the mid-2000s. We explore a particular type of mortgage fraud: the overstatement of income on mortgage applications. We define “income ov

The Consequences of Mortgage Credit Expansion: Evidence from the 2007 Mortgage Default Crisis

We demonstrate that a rapid expansion in the supply of mortgages driven by disintermediation explains a large fraction of recent U.S. house price appreciation and subsequent mortgage defaults. We identify the effect of shifts in the supply of mortgage credit by exploiting within-county variation across zip codes that differed in latent demand for mortgages in the mid 1990s. From 2001 to 2005, high latent demand zip codes experienced large relative decreases in denial rates, increases in mortgages originated, and increases in house price appreciation, despite the fact that these zip codes experienced significantly negative relative income and employment growth over this time period. These patterns for high latent demand zip codes were driven by a sharp relative increase in the fraction of loans sold by originators shortly after origination, a process which we refer to as "disintermediation." The increase in disintermediation-driven mortgage supply to high latent demand zip codes from 2001 to 2005 led to subsequent large increases in mortgage defaults from 2005 to 2007. Our results suggest that moral hazard on behalf of originators selling mortgages is a main culprit for the U.S. mortgage default crisis.

The Effects of Fiscal Stimulus: Evidence from the 2009 ‘Cash for Clunkers’ Program

A key rationale for fiscal stimulus is to boost consumption when aggregate demand is perceived to be inefficiently low. We examine the ability of the government to increase consumption by evaluating the impact of the 2009 “Cash for Clunkers” program on short and medium run auto purchases. Our empirical strategy exploits variation across U.S. cities in ex-ante exposure to the program as measured by the number of “clunkers” in the city as of the summer of 2008. We find that the program induced the purchase of an additional 360,000 cars in July and August of 2009. However, almost all of the additional purchases under the program were pulled forward from the very near future; the effect of the program on auto purchases is almost completely reversed by as early as March 2010 – only seven months after the program ended. The effect of the program on auto purchases was significantly more short-lived than previously suggested. We also find no evidence of an effect on employment, house prices, or household default rates in cities with higher exposure to the program.

The role of banks in corporate finance

Thesis (Ph. D.)--Massachusetts Institute of Technology, Dept. of Economics, 2005.Includes bibliographical references.This dissertation consists of three chapters that examine the importance of commercial banks in the financing decisions of corporations. The first chapter focuses on syndicated loans. The syndicated loan market is an increasingly important source of corporate finance, with over $1 trillion in new syndicated loans signed annually. The first chapter empirically explores the syndicated loan market with an emphasis on how information asymmetry and renegotiation considerations influence syndicate structure and the choice of participant lenders. There are two principal findings. First, when the borrower requires more intense investigation and monitoring effort by a financial institution, the lead arranger retains a larger portion of the loan, forms a more concentrated syndicate, and chooses participants that are closer to the borrower (both geographically and in terms of previous relationships). The evidence is consistent with moral hazard in a setting of information asymmetry. The lead arranger attempts to guarantee due diligence effort by increasing its risk exposure, and the lead arranger chooses lenders that minimize information asymmetry. Second, when the borrower is more likely to need to renegotiate the loan agreement, lead arrangers add participants with very small portions of the loan to the syndicate. Given that unanimity of lenders is needed to renegotiate major terms of the loan, adding participants with small portions of the loan reduces the renegotiation surplus expected by the borrower. The evidence suggests that lenders form syndicates to reduce inefficient behavior and strategic default by borrowers. The second chapter focuses on the use of bank lines of credit by corporations. Commercial bank lines of credit are used by more U.S. corporations than any other type of debt financing. Using novel data from annual 10-K SEC filings for a random sample of public firms, I analyze how corporate lines of credits are used by firms, how they are managed by banks, and which types of firms obtain lines of credit. The evidence suggests that lines of credit are the incremental source of debt financing for firms, and that banks carefully manage their use through covenants on profitability. Among firms that have lines of credit, a negative earnings shock leads to a restriction of the unused portion of the lines. Among all firms, only firms with high profitability are able to obtain lines of credit. The results suggest that lines of credit provide bank-managed flexibility for the firms that are able to obtain them, but only profitable firms are awarded this flexibility. In the third chapter, I examine the increasing prevalence of commercial banks in the corporate debt underwriting market. The relaxation of restrictions on commercial bank underwriting, culminated in the passage of the Financial Services Modernization Act of 1999, has initiated a major change in debt underwriting markets facing borrowing firms. For the first time since the 1920s, financial institutions are able to jointly produce private lending and underwriting services. Using fixed effects regressions on a panel of 4,553 debt issues by 509 firms from 1990 to 2003, I find that issuing firms receive a 10 to 15 percent reduction in underwriting fees, which is driven by commercial banks jointly offering lending and underwriting services. I show firms are no more locked in to financial relationships after deregulation than before, and that issuing firms add multiple lead managers to prevent a lending commercial bank underwriter from gaining too much power over the firm. While a number of papers analyze commercial bank entry, this work in this chapter is the first to use the effect of exogenous deregulation on within-firm variation over time to estimate key parameters. This methodological contribution is important; I show that cross section (or pooled) regressions produce biased and inconsistent estimates of the effect of commercial banks on yield spreads. The fixed effects strategy employed here calls into question the result in previous research that commercial banks obtain lower yield spreads for borrowing firms.by Amir Sufi.Ph.D