Tag: finance

Brittany Almquist Lewis, assistant professor of finance at Olin, recently investigated part of the global financial crisis of 2008-2009.

Her focus: independent mortgage companies, which operated outside the commercial banking sector. (Such companies made up a third of the mortgage lending market before the financial crisis and have grown to 50% of the market post-crisis.)

Unlike banks, these mortgage companies didn’t take deposits. They didn’t get insurance. They weren’t regulated. But, as Lewis said, they could do “risky things.” And they did.

The mortgage companies relied on credit-line funding—heavily. Yet, no direct evidence existed about who their funders were or how they operated, Lewis said.

“These questions have important implications for financial stability—not only for the housing market but also for commercial real estate and collateralized loan obligations.”

House of cards

Lewis hand-collected data on 12 of the largest public independent mortgage companies’ credit lines between 2004 and 2006. She established the following:

• The credit lines were collateralized by mortgage loans;
• The credit lines took the form of master repurchase agreements (contracts defining the purchase and resale of collateral) or “repos.”
• The credit lines were funded by the largest, interconnected dealer-banks, such as Credit Suisse, UBS, Lehman Brothers and Bear Stearns, to name a few.

Lewis also collected data on the value of collateral that dealers reported was eligible for reuse.

By connecting a dealer’s collateral to the same dealer’s funding, she was able to causally link dealers’ increased credit supply to an act that Congress passed in April 2005: the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA). She then used mortgage-origination data to analyze the resulting impact on households. Her research resulted in the paper “Creditor Rights, Collateral Reuse, and Credit Supply,” accepted at the Journal of Financial Economics.

“They are all dependent on each other. As soon as one link broke, all the links would break.”

Brittany Almquist Lewis

As it turned out, Lewis discovered that BAPCPA, which changed the bankruptcy process for mortgage collateral before the financial crisis, contributed to the housing boom—and the bust.

BAPCPA granted special treatment for repo trading using mortgage collateral.

The change allowed mortgage dealers to overleverage assets—and allowed them to take on more debt backed by those mortgages, Lewis found.

In addition, her research found “an increase in the re-use of these assets, meaning that two dealers could have money extended  with the same mortgage assets backing both trades,” she said.

Think of it as doubling the leverage of what’s recorded on the dealers’ balance sheets.

Plus, Lewis learned, the BAPCPA policy change led to the decline of the underlying assets themselves: The quality of the mortgages was deteriorating.

Hence, fragile mortgages ultimately backed the interlocking trades of large dealer banks.

“If one of these trades fell, it would be like a house of cards,” Lewis said. “They are all dependent on each other. As soon as one link broke, all the links would break.”

The situation “was setting up a perfect storm.”

Silicon Valley Bank

Why is this relevant today?

“None of these things are at play in the financial sector right now,” Lewis said. After the financial crisis, the Federal Reserve brought dealer-banks under bank holding status, making them part of the regulated banking sector. “Now they’re actually banks.”

In addition, “they don’t have these interlocking repo chains that are all backed by the same mortgage assets. And the assets themselves are not deteriorating in quality.”

Silicon Valley Bank’s collapse in March after a run on deposits was not the subject of Lewis’ paper. But her research, she said, does give an argument for why US taxpayers should not bail it out.

“We have a totally different environment with the run on SVB than we did during the financial crisis,” she said.

“Some banks, yes, are going to be connected to it, but they’re not the largest banks. They’re not the 12 most systemically important banks in the United States.”

In the global financial crisis, the interlocking banks were the most financially important, including Lehman Brothers, Bear Stearns, Goldman Sachs, Bank of America, Credit Suisse, UBS and others, all with close to a trillion dollars and more in assets, Lewis noted.

SVB didn’t have anywhere close to those assets. Yes, it had uninsured deposits, and tech firms ran on those deposits, Lewis said.

“But the tech firms themselves aren’t necessarily failing, and they aren’t backed by other banks, and the banks aren’t trading debt that was repackaged and then resold to really large, systemically important banks,” she said.

“These houses of cards are not stacked in the same way that they were stacked before the financial crisis.”

A new study finds wide disparities in the prices investors pay when buying and selling stocks through six popular brokerages. 

TD Ameritrade delivered the best prices, and Fidelity Investments, E*Trade and Robinhood Markets Inc. followed. Two trading platforms from Interactive Brokers Group Inc. came in at the bottom.

The experiment “reveals an astonishing dispersion in the quality of price execution across our sample of six brokerage accounts,” the authors write. They found the costs incurred in a transaction ranged from -0.07 to -0.46%, excluding any commissions. The average price improvement varied from 3 to 8 cents a share, which may not sound like much until you consider how many millions of trades people make daily.

14 million trades a day

The five brokers’ daily trading volume is 14 million daily trades, or 3.6 billion a year. The average retail trade of $8,000 translates into $28 trillion traded annually. So, for every one basis point of price execution difference, the annual cost to retail traders is $2.8 billion, according to the research.

“In that context, our observed execution differences are economically very large,” the authors say in their working paper, “The ‘Actual Retail Price’ of Equity Trades.”

“While we were aware that such trading would not be ‘free,’ we were surprised by the range of execution prices for our simultaneous identical trades.”

The researchers, including Olin Assistant Professor of Finance Xing Huang, bought and sold stocks 85,000 times over nearly six months. At the peak, their trades numbered more than 1,000 a day. They tried to place the same trades simultaneously with different brokers and measured the prices they got.

“Consumers should realize that zero commission doesn’t mean free trading, and the transaction costs could vary across brokers,” Huang said.

“Although we show that the differences are economically large on the aggregate level, the differences may be small on the individual level. While some consumers may be more concerned about other features of brokers, consumers who care about execution prices may be interested in our results.”

Different prices for the same trades

According to the research results, the price dispersion is because off-exchange wholesalers give different execution prices to brokers for the same trades.

“The difference in execution costs between these different brokers is huge, and nobody knows it,” Schwarz said.

Said Huang, “We were quite surprised by off-exchange wholesalers systematically give different execution prices to different brokers, even for the same trades.”

The findings indicate that the current disclosure regime is inadequate and provides limited information regarding the quality of price across brokers. “In practice,” the authors write, “it is very hard to compare the actual retail price execution quality of different brokers.”

The researchers spent their own money on the experiment, and they lost about $23,000 doing the trades, lead author Christopher Schwarz, of the University of California at Irvine, told The Wall Street Journal in a September 16 article.

Their impression was that they couldn’t use their research accounts since the experiment involved trading and uncertain outcomes, Huang said. “We did not want to get any funding from institutions because we didn’t want any potential conflicts of interest compromise our independent opinion.”

Riots that resulted in anywhere from 10 to 1,000-plus deaths in their hometowns ultimately influenced lending decisions among hundreds of loan managers in India — and the effect endured for decades, a new study reveals. The research shows a country’s ethnic fissures can create crevasses in its road to economic progress.

Those are the findings by WashU Olin’s Janis Skrastins and three other researchers, who analyzed the lending decisions of about 1,800 Hindu loan managers at a large, public sector Indian bank.

More than 250 of those loan managers had experienced fatal Hindu-Muslim riots in their hometowns when they were children. Later, as grown men, those loan managers favored lending to Hindu borrowers over Muslim borrowers.

“The most important takeaway is that your early childhood experiences of ethnic conflict can have long-lasting effects,” said Skrastins, assistant professor of finance. And the experiences “can actually lead to misallocation of resources even in the longer term.”

The researchers’ paper, “Experience of Communal Conflicts and Inter-group Lending,”  provides microeconomic evidence on the link between inter-group frictions and economic transactions. It is forthcoming in the Journal of Political Economy.

Muslim borrowers less likely to default

The loan managers’ favoritism persisted even as the loans they made to Muslims were less likely to default, the research revealed.

“What’s very, very important is the money or the profit that the officers expect to make on one Muslim borrower is going to be higher than on a Hindu,” Skrastins said.

“So that means they’re just giving money as a favor to some of their own group,” and creating disadvantages for another.

The researchers also discovered that loan managers’ bias persisted throughout their careers, suggesting “the economic costs of ethnic conflict are long-lasting, potentially spanning across generations,” Skrastins said.

The paper documents the lifelong consequences of racially divisive personal experiences in childhood, rather than shorter-term increases in in-group favoritism as a result of current events. The authors say that, to their knowledge, this is the first research on the topic.

Lending decisions over seven years

Skrastins, Raymond Fisman of Boston University, and Arkodipta Sarkar and Vikrant Vig, both of the London Business School, analyzed loan managers’ lending decisions from 1999 to 2006.

In tandem, they used a database of Hindu-Muslim riots from 1950 to 1995, along with each loan manager’s year and city of birth. With that information, they could infer whether ethnic riots erupted in a loan officer’s hometown during his childhood.

All men in the sample were born after 1950 and joined the bank no later than 1995.

The researchers measured riot exposure based on riot deaths in the loan managers’ hometowns from the year they were born to when they joined the bank. Generally, new loan managers at the bank are in their early 20s. Since the bank forbids any loan manager from working in his hometown, they necessarily leave their birthplace when they join the bank.

Because the bank requires loan managers and borrowers to list their religion, the researchers also had access to that information.

‘Riot-exposure’ defined

In their main results — which used local riot deaths of 10 or more people to define “riot exposure” — they found this: The presence of a riot-exposed loan manager was associated with 4 percentage points higher lending to Hindu borrowers relative to all other borrowers.

They also found that the presence of a riot-exposed loan manager was associated with a 2.5 percentage point increase in defaults by Hindu borrowers relative to Muslim borrowers.

The researchers also examined lending decisions as a function of when the loan manager was first exposed to Hindu-Muslim violence. Riot exposure before he was 10 years old was “the most important determinant of later lending decisions,” they found.

In their final analysis, the researchers examined loan managers’ decisions tied to the 2002 Gujarat riots, which left more than 1,000 people dead.

They found that lending to Muslims declined by 8 percentage points with the arrival of a branch manager who had been stationed in Gujarat at the time of the riots.

At cross-purposes with themselves

In some ways, the loan managers shoot themselves in the foot by shunning Muslim borrowers.

Loan managers in Indian state banks have incentives to perform well, the researchers note. Some rewards are promotions to higher grades with higher compensation — or better postings. Loan managers may be dispatched to places with better perks such as better schools, larger houses, the use of a car, or control over a larger portfolio.

If a loan manager is performing poorly, he risks being sent to places with weak infrastructures and lousy schools. Basically, when a loan officer plays favorites in lending that worsens his repayment rates, he hurts himself, the researchers point out.

Photo illustration by Olin Creative Director Katie Wools.

Part of a series about summer internships from Olin MBA ’20 students. Today we hear from Atiyana Evelyn, who worked at Capital Group as a summer marketing associate.

This summer I worked in Los Angeles at Capital Group doing marketing in their North America distribution department. When looking for internships, I never thought I would end up in the financial services industry.

As someone whose background is heavily marketing, with a brand focus, it was definitely a shift in gears. When preparing for my interview, I researched a lot about the company and what they did within that industry.

In addition to that, I looked at their products and tried to understand them as much as I could prior to going to LA to interview in person. During my interview, I actually said verbatim “I’m not going to lie, I don’t know anything about finance, but I know a lot about marketing and I am willing to learn.”

Honestly, Olin prepared me immensely for my internship this summer. It allowed me to have the skill set to jump into the learning curve quickly and become acclimated to my new environment.

For my specific role, I didn’t have to know too much about the financial services industry, but I have learned so much and am excited to apply what I’ve learned to my real life experiences.

I think one of the most valuable things about summer internships is being able to find your place. You have the opportunities to figure out what you want to do with your life and the direction you want to take it into.

I have loved marketing since I was 15 and I am glad to know that this is something I still want to pursue, regardless of the industry that I am in placed in. I am glad that Olin has provided me with the opportunities that I have participated in and I am excited to see what the future holds.

She grew up playing the accordion, but Xing Huang transferred her keyboard skills to the piano when she moved the US to study finance. Prof. Huang was pleased to find WashU’s Music Department practice rooms located directly across the street from Olin’s Simon Hall.

Listen to Olin’s newest member of the finance faculty practice her piano skills in the video above.

Prof. Huang was an assistant professor of finance at Michigan State University before joining Olin. Her research into behavioral finance, asset pricing, and investor behavior are all topics in her class this semester where student teams are given a million dollars to invest. Don’t worry – it’s virtual money that they use in a  simulation trading game that puts students in the driver’s seat of a brokerage account to experience the ups and downs of stock trades and the gyrations of the market.

Professor Huang’s bio:

PhD 2013, University of California, Berkeley
MA 2007, Peking University, Guanghua School of Management
BA 2005, Peking University, Guanghua School of Management

Awards/Honors:

• Best Paper Award, CICF XY Investments, 2016
• Broad College’s Summer Research Grant Award, 2016
• Stuart I. Greenbaum Best Finance Ph.D. Dissertation Award, Finalist, 2012
• Graduate Division Travel Grant, University of California, Berkeley, 2011
• Student Travel Grant Award, American Finance Association, 2011
• Dean’s Normative Time Fellowship, University of California, Berkeley, 2010
• Shapiro Fellowship, University of California, Berkeley, 2007