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2010 Working Papers

  • WP 10-25 | Innovation Spillovers in Industrial Cities


    Laura Crispin Subhra Saha Bruce Weinberg

    Abstract

    Older, industrial cities have suffered with the shift from manufacturing to services, but the increased importance of innovation as an economic driver may help industrial cities, which are often rich in the institutions that generate innovation. This paper studies how innovation is related to wages for different types of workers (e.g., more-educated versus less, and younger versus older) and to real estate prices for cities. We also study industrial and occupational employment shares. Our estimates indicate that innovation and aggregate education are associated with greater productivity in cities. They indicate that innovation and aggregate education impact wages less in industrial cities, but that they impact real estate prices more. We also find greater effects of innovation and aggregate education for more-educated and prime-aged workers. We pay particular attention to controlling for causality and adjustments of factor inputs. Read More

  • WP 10-24 | Caught Between Scylla and Charybdis? Regulating Bank Leverage When There Is Rent Seeking and Risk Shifting


    Viral Acharya Hamid Mehran Anjan Thakor

    Abstract

    Banks face two moral hazard problems: asset substitution by shareholders (e.g., making risky, negative net present value loans) and managerial rent seeking (e.g., investing in inefficient “pet” projects or simply being lazy and uninnovative). The privately-optimal level of bank leverage is neither too low nor too high: It balances efficiently the market discipline imposed by owners of risky debt on managerial rent-seeking against the asset-substitution induced at high levels of leverage. However, when correlated bank failures can impose significant social costs, regulators may bail out bank creditors. Anticipation of this generates an equilibrium featuring systemic risk in which all banks choose inefficiently high leverage to fund correlated assets. A minimum equity capital requirement can rule out asset substitution but also compromises market discipline by making bank debt too safe. The optimal capital regulation requires that a part of bank capital be unavailable to creditors upon failure, and be available to shareholders only contingent on good performance. Read More

  • WP 10-23 | U.S. Intervention and the Early Dollar Float: 1973-1981


    Michael Bordo Owen F. Humpage Anna Schwartz

    Abstract

    The dollar’s depreciation during the early floating rate period, 1973–1981, was a symptom of the Great Inflation. In that environment, sterilized foreign exchange interventions were ineffective in halting the dollar’s decline, but they showed a limited ability to smooth dollar movements. Only after the Volcker FOMC changed its monetary-policy approach and demonstrated a willingness to maintain a disinflationary stance despite severe economic weakness and high unemployment did the dollar begin a sustained appreciation. Also contributing to the ineffectiveness of the interventions was the Desk’s method of operation. The small, covert interventions, particularly prior to 1977, seemed inconsistent with an expectations channel of influence, and financing intervention with short-term borrowed funds seemed inconsistent with a portfolio-balance channel of influence. The Desk never clearly articulated an intervention transmission mechanism. The episode indicated the shortcomings of sterilized intervention and led to their cessation in April 1981. Read More

  • WP 10-22 | Blowing It Up and Knocking It Down: The Effect of Demolishing High-Concentration Public Housing on Crime


    Dionissi Aliprantis Daniel Hartley

    Revisions: WP 10-22R

    Abstract

    Despite popular accounts that link public housing demolitions to spatial redistribution of crime and possible increases in crime, little systematic research has analyzed the neighborhood or citywide impact of demolitions on crime. In Chicago, which has conducted the largest public housing demolition program in the United States, I find that public housing demolitions are associated with a 10 percent to 20 percent reduction in murder, assault, and robbery in neighborhoods where the demolitions occurred. Furthermore, violent crime rates fell by about the same amount in neighborhoods that received the most displaced public-housing households relative to neighborhoods that received fewer displaced public-housing households, during the period when these developments were being demolished. This suggests violent crime was not simply displaced from the neighborhoods where demolitions occurred to neighborhoods that received the former public-housing residents. Read More

  • WP 10-03R | Debt Overhang in a Business Cycle Model


    Filippo Occhino Andrea Pescatori

    Original Paper: WP 10-03

    Abstract

    Legislation aimed at stabilizing housing markets since the recession has focused on providing funding to acquire and remediate foreclosed and abandoned homes or providing financial assistance and incentives to purchase homes. Cuyahoga County has received over $100 million in such funds since 2008. We investigate the impact of these funds on vacancy rates. We examine neighborhoods in Cuyahoga County where National Stabilization Program dollars were spent and find that the program helped reduce vacancies in neighborhoods where properties were primarily purchased for consumption purposes. Read More

  • WP 10-21 | Homeownership for the Long Run: An Analysis of Homeowner Subsidies


    O. Emre Ergungor

    Revisions: WP 10-21R

    Abstract

    This paper examines the impact of interest-rate and down-payment subsidies on default rates and losses given default, and finds that down-payment subsidies create successful homeowners at a lower cost than interest-rate subsidies. Read More

  • WP 10-20 | The Importance of Financial Market Development on the Relationship between Loan Guarantees for SMEs and Local Market Employment Rates


    Craig Armstrong Ben R. Craig William Jackson III James Thomson

    Abstract

    We empirically examine whether a major government intervention in the small firm credit market yields significantly better results in markets that are less financially developed. The government intervention that we investigate is SBA guaranteed lending. The literature on financing small and medium size enterprises (SMEs) suggests that small firms may be exposed to a particular type of market failure associated with credit rationing. And SMEs in markets that are less financially developed will likely face a greater degree of this market failure. To test our hypothesis, we use the level of bank deposits per capita as our relative measure of financial market development, and we use local market employment rates as our measure of economic performance. After controlling for the appropriate cross-sectional market characteristics, we find that SBA-guaranteed lending has a significantly more (less) positive impact on the average annual level of employment when the local market is relatively less (more) financially developed. This result has important implications for public policy directives concerning where SBA-guaranteed lending should be directed. Read More

  • WP 10-19 | Determinants and Consequences of Mortgage Default


    Yuliya Demyanyk Ralph Koijen SJ Otto Van Hemert

    Abstract

    We study a unique data set of borrower-level credit information from TransUnion, one of the three major credit bureaus, which is linked to a database containing detailed information on the borrowers’ mortgages. We find that the updated credit score is an important predictor of mortgage default in addition to the credit score at origination. However, the 6-month change in the credit score also predicts default: A positive change in the credit score significantly reduces the probability of delinquency or foreclosure. Next, we analyze the consequences of default on a borrower’s credit score. The credit score drops on average 51 points when a borrower becomes 30-days delinquent on his mortgage, but the effect is much more muted for transitions to more severe delinquency states and even for foreclosure. Read More

  • WP 10-18 | The Effects of Capital Market Openness on Exchange Rate Pass-through and Welfare


    Sanchita Mukherjee

    Abstract

    This paper analyzes the impact of capital market openness on exchange rate pass-through and subsequently on the social loss function in an inflation targeting small open economy under a pure commitment policy. Applying the intuition behind the macroeconomic trilemma, the author examines whether a more open capital market in an inflation-targeting country improves the credibility of the central bank and consequently reduces exchange rate pass-through. First, the effect of capital openness on exchange rate pass-through is empirically examined using a New Keynesian Phillips curve. The empirical investigation reveals that limited capital openness leads to greater pass-through from the exchange rate to domestic inflation, which raises the marginal cost of deviation from the inflation target. This subsequently worsens the inflation output-gap trade-off and increases the social loss of the inflation targeting central bank under pure commitment. Read More

  • WP 10-17 | The Ins and Outs of Unemployment in the Long Run: A New Estimate for the Natural Rate?


    Murat Tasci

    Revisions: WP 10-17R

    Abstract

    In this paper, we present a simple, reduced-form model of comovements in real activity and worker fl ows and use it to uncover the trend changes in these flows, which determine the trend in the unemployment rate. We argue that this trend rate has several key features that are reminiscent of a “natural rate.” We show that the natural rate, measured this way, has been relatively stable in the last decade, even after the most recent recession. This was due to two opposing trend changes: On the one hand, the trend in the job-finding rate, after being relatively stable for decades, declined by a significant margin after 2000, pushing trend unemployment up. But the trend in the separation rate has somewhat offset that effect, with a continued secular decline since the early 1980s. We also show that, contrary to the business-cycle movements of the unemployment rate, most of the low-frequency variation in the rate can be accounted for by changes in the trend of the separation rate, not the job-finding rate. Read More

  • WP 10-16 | Liquidity and Asset Market Dynamics


    Guillaume Rocheteau Randall Wright

    Abstract

    We study economies with an essential role for liquid assets in transactions. The model can generate multiple stationary equilibria, across which asset prices, market participation, capitalization, output and welfare are positively related. It can also generate a variety of nonstationary equilibria, even when fundamentals are deterministic and time invariant, including periodic, chaotic, and stochastic (sunspot) equilibria with recurrent market crashes. Some equilibria have asset price trajectories that resemble bubbles growing and bursting. We also analyze endogenous private and public liquidity provision. Sometimes it is efficient to have enough liquid assets to satiate demand; other times it is not. Read More

  • WP 10-15 | Cleaning up the Refuse from a Financial Crisis: The Case for a Resolution Management Corporation


    James Thomson

    Abstract

    Systemic banking and financial crises invariably result in the transfer of a large volume of distressed financial assets into the hands of the government, which must later dispose of them. The fiscal and economic costs of the crisis and the speed of recovery depend on how effectively the government’s salvage operations can re-privatize these assets. To maximize the operations’ effectiveness, I propose that the government create a temporary resolution management corporation. Drawing on Kane’s (1990) asset-salvage principles, as well as the U.S. experience with special-purpose entities for managing and disposing of assets stripped from distressed financial firms’ balance sheets, I propose a design for such a corporation. Read More

  • WP 10-14 | Interbank Tiering and Money Center Banks


    Ben R. Craig Goetz von Peter

    Abstract

    This paper provides evidence that interbank markets are tiered rather than flat, in the sense that most banks do not lend to each other directly but through money center banks acting as intermediaries. We capture the concept of tiering by developing a core-periphery model, and devise a procedure for tting the model to real-world networks. Using Bundesbank data on bilateral interbank exposures among 1800 banks, we find strong evidence of tiering in the German banking system. Econometrically, bank-specific features, such as balance sheet size, predict how banks position themselves in the interbank market. This link provides a promising avenue for understanding the formation of financial networks. Read More

  • WP 10-13 | Private-Activity Municipal Bonds: The Political Economy of Volume Cap Allocation


    Stephan D. Whitaker

    Abstract

    State governments allocate authority, under a federally imposed cap, to issue taxexempt bonds that fund “private activities” such as industrial expansion, student loans, and low-income housing. This paper presents political economy models of the allocation process and an empirical analysis. Due to an idiosyncrasy of the tax code, the annual per capita volume cap varies widely between states. I estimate that, on average, there is an additional $0.80 per capita per year of borrowing for each additional dollar per capita of volume cap. This confirms that the cap is a binding constraint in most cases, and authority to issue tax-exempt bonds is a scarce resource. I find that mortgage revenue bonds and student loan bonds are the most responsive to differences in the cap. The gross state product and employment in manufacturing and utilities drive allocations to industrial development bonds and utilities bonds. Read More

  • WP 10-12 | Redshirting, Compulsory Schooling Laws, and Educational Attainment


    Dionissi Aliprantis

    Abstract

    A wide literature uses date of birth as an instrument to study the causal effects of educational attainment. This paper shows how parents delaying their children’s initial enrollment in kindergarten, a practice known as redshirting, can make estimates obtained through this identification framework all but impossible to interpret. A latent index model is used to illustrate how the monotonicity assumption in this framework is violated if redshirting decisions are made in a setting of essential heterogeneity. Empirical evidence is presented from the ECLS-K data set that favors this scenario; redshirting is common and heterogeneity in the treatment effect of educational attainment is likely a factor in parents’ redshirting decisions. Read More

  • WP 10-11 | The Effect of Foreclosures on Nearby Housing Prices: Supply or Disamenity


    Daniel Hartley

    Revisions: WP 10-11R

    Abstract

    A number of studies have measured negative price effects of foreclosed residential properties on nearby property sales. However, only one other study addresses which mechanism is responsible for these effects. I measure separate effects for different types of foreclosed properties and use these estimates to decompose the effects of foreclosures on nearby home prices into a component that is due to additional available housing supply and a component that is due to disamenity stemming from deferred maintenance or vacancy. I estimate that each extra unit of supply decreases prices within 0.05 miles by about 1.2 percent while the disamenity stemming from a foreclosed property is near zero. Read More

  • WP 07-23R | The National Banking System: A Brief History


    Bruce Champ

    Original Paper: WP 07-23 | Revisions: WP 07-23R2

    Abstract

    During the period of the National Banking System (1863-1913), national banks could issue bank notes backed by holdings of eligible U.S. government securities. This paper presents an overview of the legal and financial history of this period. It begins with the reasons the National Banking System was created. It also examines the rules of operation for national banks as established by the National Banking Act and its subsequent revisions. Furthermore, the paper serves as a brief financial history of the period, examining the various forces that shaped the environment in which national banks operated. This paper represents a preliminary chapter from a forthcoming monograph on the period of the National Banking System. Other chapters of the monograph appear in the Federal Reserve Bank of Cleveland’s working paper series as working paper 07-19R and working paper 07-22R. Read More

  • WP 07-22R | The National Banking System: The National Bank Note Puzzle


    Bruce Champ

    Original Paper: WP 07-22 | Revisions: WP 07-22R2

    Abstract

    The era of the National Banking System (1863-1913) has been a puzzling one for monetary theorists and economic historians for well over a century. The puzzles associated with this period take various forms. Despite calculations of high profit rates on note issue for certain periods of the era, national banks never fully utilized their note-issuing powers. Relatedly, the behavior of interest rates during the period is also puzzling given the regime of bank note issuance put in place by the National Bank Acts. On the surface, it appears that an arbitrage condition is broken. The observed inelasticity in aggregate national bank note issue also is puzzling, particularly given the behavior of interest rates. This paper examines many of the puzzles of the national banking era and provides a summary of the current attempts to explain those puzzles. This paper represents a preliminary chapter from a forthcoming monograph on the period of the National Banking System. Other chapters of the monograph appear in the Federal Reserve Bank of Cleveland’s working paper series as working paper 07-19R and working paper 07-23R. Read More

  • WP 07-19R | The National Banking System: Empirical Observations


    Bruce Champ

    Original Paper: WP 07-19 | Revisions: WP 07-19R2

    Abstract

    This paper provides a summary of the main features of U.S. financial and banking data during the period of the National Banking System (1863-1914). The purpose of the paper is to provide an overview of the stylized facts associated with the era, with an emphasis on those impinging on national bank behavior. The paper takes a detailed look at key elements of national bank balance sheets over time, over the seasons, and during panic periods. The interesting and puzzling patterns of interest rate movements during the era also are examined. The paper introduces a new set of disaggregated data on the national bank era that has not been examined by prior research. As data are presented in the paper, some of the key puzzles associated with the era are introduced. This paper represents a preliminary chapter from a forthcoming monograph on the period of the National Banking System. Other chapters of the monograph appear in the Federal Reserve Bank of Cleveland's working paper series as working paper 07-22R and working paper 07-23R. Read More

  • WP 10-10 | Liquidity Creation without a Lender of Last Resort: Clearing House Loan Certificates in the Banking Panic of 1907


    Ellis W. Tallman Jon Moen

    Abstract

    We employ a new data set comprised of disaggregate figures on clearing house loan certificate issues in New York City to document how the dominant national banks were crucial providers of temporary liquidity during the Panic of 1907. Clearing house loan certificates were essentially “bridge loans” arranged between clearing house members. They enabled and were issued in anticipation of gold imports, which took a few weeks to arrive. The large, New York City national banks acted as private liquidity providers by requesting (and the New York Clearing House issuing) a volume of clearing house loan certificates beyond their own immediate liquidity needs, in accord with their role as central reserve city banks in the national banking system. Read More

  • WP 10-09 | Banking and Financial Crises in United States History: What Guidance Can History Offer Policymakers?


    Ellis W. Tallman Elmus Wicker

    Abstract

    This paper assesses the validity of comparisons between the current financial crisis and past crises in the United States. We highlight aspects of two National Banking Era crises (the Panic of 1873 and the Panic of 1907) that are relevant for comparison with the Panic of 2008. In 1873, overinvestment in railroad debt and the default of railroad companies on that debt led to the failure of numerous brokerage houses, precursor to the modern investment bank. During the Panic of 1907, panic-related deposit withdrawals centered on the less regulated trust companies, which had only indirect access to the existing lender of last resort, similar to investment banks in 2008. The popular press has made numerous references to the banking crises of the Great Depression as relevant comparisons to the recent crisis. This paper argues that such an analogy is inaccurate. The previous banking crises in U.S. history reflected widespread depositor withdrawals whereas the recent panic arose from counterparty solvency fears and large counterparty exposures among large complex financial intermediaries. Read More

  • WP 10-08 | Endogenous Gentrification and Housing-Price Dynamics


    Veronica Guerrieri Daniel Hartley Erik Hurst

    Revisions: WP 10-08R1 | WP 10-08R2 | WP 10-08R3

    Abstract

    In this paper, we begin by documenting substantial variation in house-price growth across neighborhoods within a city during citywide housing price booms. We then present a model which links house-price movements across neighborhoods within a city and the gentrification of those neighborhoods in response to a citywide housing-demand shock. A key ingredient in our model is a positive neighborhood externality: individuals like to live next to richer neighbors. This generates an equilibrium where households segregate based upon their income. In response to a citywide demand shock, higher-income residents will choose to expand their housing by migrating into the poorer neighborhoods that directly abut the initial richer neighborhoods. The in-migration of the richer residents into these border neighborhoods will bid up prices in those neighborhoods, causing the original poorer residents to migrate out. We refer to this process as “endogenous gentrification.” Using a variety of data sets and using Bartik variation across cities to identify city-level housing demand shocks, we find strong empirical support for the model’s predictions. Read More

  • WP 10-07 | U.S. Foreign-Exchange-Market Intervention during the Volcker-Greenspan Era


    Michael Bordo Owen F. Humpage Anna Schwartz

    Abstract

    The Federal Reserve abandoned foreign-exchange-market intervention because it conflicted with the System’s commitment to price stability. By the early 1980s, economists generally concluded that, absent a portfolio-balance channel, sterilized foreign-exchange-market intervention did not provide central banks with a mechanism for systematically influencing exchange rates independent of their monetary policies. If intervention were to have anything other than a fleeting, hit-or-miss effect on exchange rates, monetary policy had to support it. Exchange rates, however, often responded to U.S. monetary-policy initiatives, so intervention to offset or reverse those exchange-rate responses can seem a contrary policy move and can create uncertainty about the strength of the System’s commitment to price stability. That the U.S. Treasury maintained primary responsibility for foreign-exchange intervention only compounded this uncertainty. In addition, many FOMC participants feared that swap drawings and warehousing could contravene the Congressional appropriations process and, therefore, potentially pose a threat to System independence, a necessary condition for monetary-policy credibility. Read More

  • WP 10-06R | Lending Patterns in Poor Neighborhoods


    Francisca Richter Ben R. Craig

    Abstract

    Concentrated poverty has been said to impose a double burden on those that confront it. In addition to an individual’s own fi nancial constraints, institutions and social networks of poor neighborhoods can further limit access to quality services and resources for those that live there. This study contributes to the characterization of subprime lending in poor neighborhoods by including a spatial dimension to the analysis, in an attempt to capture social—endogenous and exogenous interaction—effects differences in poor and less poor neighborhoods. The analysis is applied to 2004-2006 census tract level data in Cuyahoga County, home to Cleveland, Ohio, a region that features urban neighborhoods highly segregated by income and race. The patterns found in poor neighborhoods suggest stronger social effects inducing subprime lending in comparison to less poor neighborhoods. Read More

  • WP 10-05 | Systemic Risk Analysis Using Forward-Looking Distance-to-Default Series


    Martin Zambrana

    Abstract

    Based on contingent claims theory, this paper develops a method to monitor systemic risk in the European banking system. Aggregated Distance-to-Default series are generated using option prices information from systemically important banks and the DJ STOXX Banks Index. These indicators provide methodological advantages in monitoring vulnerabilities in the banking system over time: 1) they capture interdependences and joint risk of distress in systemically important banks; 2) their forward-looking feature endow them with early signaling properties compared to traditional approaches in the literature and other market-based indicators; and 3) they produce simultaneously both smooth and informative long-term signals and quick and clear reaction to market distress. Read More

  • WP 10-04 | A Structural Model of Contingent Bank Capital


    George Pennacchi

    Abstract

    This paper develops a structural credit risk model of a bank that issues deposits, shareholders’ equity, and fi xed or floating coupon bonds in the form of contingentcapital or subordinated debt. The return on the bank’s assets follows a jump-diffusion process, and default-free interest rates are stochastic. The equilibrium pricing of the bank’s deposits, contingent capital, and shareholders’ equity is studied for various parameter values characterizing the bank’s risk and the contractual terms of its contingent capital. Allowing for the possibility of jumps in the bank’s asset value, as might occur during a financial crisis, has distinctive implications for valuing contingent capital. Credit spreads on contingent capital are higher the lower is the value of shareholders’ equity at which conversion occurs and the larger is the conversion discount from the bond’s par value. The effect of requiring a decline in a financial stock price index for conversion (dual price trigger) is to make contingent capital more similar to non-convertible subordinated debt. Read More

  • WP 09-05R | Deposit Market Competition, Costs of Funding and Bank Risk


    Ben R. Craig Valeriya Dinger

    Original Paper: WP 09-05

    Abstract

    In this paper we revisit the long debate on the risk effects of bank competition and propose a new approach to the empirical estimation of the relation between deposit market competition and bank risk. Our approach accounts for the opportunity of banks to shift to wholesale funding when deposit market competition is intense. The analysis is based on a unique comprehensive dataset which combines retail deposit rates data with data on bank characteristics and with data on local deposit market features for a sample of 589 U.S. banks. Our results support the notion of a risk-enhancing effect of deposit market competition. Read More

  • WP 10-03 | Debt Overhang and Credit Risk in a Business Cycle Model


    Filippo Occhino Andrea Pescatori

    Revisions: WP 10-03R

    Abstract

    Legislation aimed at stabilizing housing markets since the recession has focused on providing funding to acquire and remediate foreclosed and abandoned homes or providing financial assistance and incentives to purchase homes. Cuyahoga County has received over $100 million in such funds since 2008. We investigate the impact of these funds on vacancy rates. We examine neighborhoods in Cuyahoga County where National Stabilization Program dollars were spent and find that the program helped reduce vacancies in neighborhoods where properties were primarily purchased for consumption purposes. Read More

  • WP 10-02 | Measuring Systemic Risk


    Viral Acharya Lasse Pedersen Thomas Philippon Matthew Richardson

    Abstract

    We present a simple model of systemic risk and show how each financial institution’s contribution to systemic risk can be measured and priced. An institution’s contribution, denoted systemic expected shortfall (SES), is its propensity to be undercapitalized when the system as a whole is undercapitalized, which increases in its leverage, volatility, correlation, and tail-dependence. Institutions internalize their externality if they are “taxed” based on their SES. Through several examples, we demonstrate empirically the ability of components of SES to predict emerging systemic risk during the nancial crisis of 2007-2009. Read More

  • WP 10-01 | A Microeconometric Investigation into Bank Interest Rate Rigidity


    Ben R. Craig Valeriya Dinger

    Revisions: WP 10-01R

    Abstract

    We use bank retail interest rates as price examples in a study of the determinants of price durations. The extraordinary richness of the data allows us to address some major open issues from the price rigidity literature, such as the functional form of the hazard of changing a price, the effect of firm and market characteristics on the duration of prices, and asymmetry in the speed of adjustments to positive and negative cost shocks. We find that the probability of a bank changing its retail rate initially (that is, in roughly the first six months of a spell) increases with time. The most important determinants of the duration of retail interest rates are the cumulated change in the money market interest rates and the policy rate since the last retail rate change. Among bank and market characteristics, the size of the bank, its market share in a given local market, and its geographical scope significantly modify retail rate durations. Read More