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Essays in Financial Intermediation and Household Finance

  • Author(s): ZHANG, DAYIN
  • Advisor(s): Wallace, Nancy
  • et al.

Finance is a significant part of any individual's life. The accessibility and quality of finance is an outcome of the financial intermediating infrastructure, and largely influences household welfare. This dissertation aims to understand how the detailed architecture of financial intermediation affects household finance in their real estate investment.

Mortgage finance plays a crucial role in the US economy and there is significant government intervention. What are the consequences of different types of government intervention in the US housing market is a central question, especially after the Great Recession. While much effort has been devoted to understanding government guarantee programs which aim to facilitate the secondary market of mortgage loans, the first chapter "Government-Sponsored Wholesale Funding and the Industrial Organization of Bank Lending" evaluates a less-studied government-sponsored wholesale funding program in support of the primary mortgage lending market--Federal Home Loan Banks (FHLB). I exploit quasi-natural variation in access to low-cost wholesale funding from the FHLB arising from bank mergers, and show that access to this funding source is associated with an 18-basis-point reduction in a bank's mortgage rates and a 16.3% increase in mortgage lending. This effect is 25% stronger for small community banks. At the market level, a census tract experiences an increase in local competition after a local bank joins the FHLB, with the market concentration index (HHI) falling by 1.5 percentage points. This intensified local competition pushes other lenders to lower their mortgage rates by 7.4 basis points, and overall market lending grows by 5%. Estimates of a structural model of the US mortgage market imply that the FHLB increases annual mortgage lending in the US by $50 billion, and saves borrowers $4.7 billion in interest payments every year, mainly through changing the competitive landscape of the mortgage market.

Another feature of the US mortgage market is its well-developed secondary market, full of various structured finance products. Among these structured finance products, credit derivatives such as credit default swaps (CDS) are largely viewed as redundant securities or side bets that do not have any influence on the underlying mortgage lending activities and household access to mortgage credit. Contrary to this view, the second chapter "Match-Fixing in the Mortgage Finance Field: Credit Default Swaps and Moral Hazard" explores the ex post moral hazard problems in the subprime mortgage backed security market, and empirically demonstrates that the existence of CDS protection alters the incentives of market participants, which affects the performance of the underlying mortgages. Specifically, CDS sellers encourage borrowers in their mortgage pool to refinance, in order to unload the CDS sellers' obligation to cover the loss of the underlying mortgages. Consequently, the mortgages in CDS referencing pools are 3.6% more likely to be refinanced and 2.1% less likely to default. To mitigate the endogeneity concern that CDS sellers choose to write CDSs on better mortgages, this paper further explores the local randomization due to the discontinuous sale of mortgages by their originators, to establish a causal relationship between CDS coverage and mortgage refinance and default performance. This paper provides the first direct evidence that credit derivatives can affect fundamental assets through the ex-post actions of derivative traders.

The third chapter "Residential Investment and the Business Cycle" focuses on the connection between household investment in housing and the macro economy. To achieve a smooth path of consumption, consumption surplus can be stored either in the form of manufacturing capital through business investment, or in the form of housing structures through residential investment. The return of business investment is exposed to the corporate bankruptcy risk, since potential bankruptcy of the holding firms would incur huge displacement cost to the specialized assets. The residential investment, however, is free from such risk due to the generic function of housing service. Therefore, the investors would shift more resource from the residential side to the business side in response to the low bankruptcy rate in economic booms. This mechanism could explain why the share of residential investment in GDP decreases before the advent of the crisis while the business investment acts in the opposite way.

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