1 4th BI-CEPR Conference on Money, Banking, and Finance “Lender Behavior During Credit Cycles” by Giovanni Dell’Ariccia, Deniz Igan, and Luc Laeven Discussion: Alex Popov (European Central Bank) October 2, 2009

2 Dell’Ariccia, Igan, and Laeven, “Lender Behavior During Credit Cycles” Motivation and goal Structure of US mortgage markets changed a lot in the last decade Entry of large players in local markets, regulatory arbitrage, increased competition Question 1: How did local market structure – entry of large national players – affect lending behavior? Question 2: How did local market conditions affect lending behavior? Question 3: Did capital requirements discipline risk-taking?

3 Dell’Ariccia, Igan, and Laeven, “Lender Behavior During Credit Cycles” Design Data –Mortgage application data using the Home Mortgage Disclosure Act –Bank balance sheet data from the Call Report –Demographic and macro info on local economic conditions –Three dimensions: lender, MSA, time –Main variable of interest: mortgage denial rates Controlling for unobservable circumstances Time trends Lender-MSA dummy interaction

4 Dell’Ariccia, Igan, and Laeven, “Lender Behavior During Credit Cycles” Main findings Macroeconomic conditions and financial innovation matter for denial rates –Lower in high-growth, low-unemployment and low self-employment MSAs –Lower in areas with widespread securitization Demand and market structure matter for denial rates –Increase with own applications –Decrease with applications to competitors –New entrants have lower denial rates Bank characteristics matter for denial rates –Smaller banks have higher denial rates –Better capitalized banks have higher denial rates –More efficient banks have lower denial rates

5 Dell’Ariccia, Igan, and Laeven, “Lender Behavior During Credit Cycles” General remarks Story? –Would be nice to have a lead-up to the paper in terms of what happened in US housing markets –Tax Reform Act 1986 home ownership rate went from 63% in 1986 to 69% in 2004 –Automatic underwriting and credit scoring since 1990s –Securitization and dispersed risk –Jumbo vs. non-jumbo loans –Finally, evolution of foreclosure rates of outstanding loans –Lower prepayment rates after 2004 (2-3 year teaser)

6 Dell’Ariccia, Igan, and Laeven, “Lender Behavior During Credit Cycles” General remarks (cntd.) Nice idea to rank bank, market, and macroeconomic characteristics in terms of relative importance However, methodology allows for contamination by unobservables: I’d like to see the following robustness check:

7 Dell’Ariccia, Igan, and Laeven, “Lender Behavior During Credit Cycles” General remarks (cntd.) Reverse causality? –Denial rates driving applications? –Deial rates driving house prices? –Authors use 1-period lags, size of effect decreases –Use demographic factors as instruments? (age composition…) Add interaction terms in regressions? –For instance, the lack of effect of new entry may be diluted by aggregation –Interact new entry with MSA characteristics –Effect of regulation might vary with market conditions Control for factors studied in “rival” papers –Concentrated vs. diversified lending (Loutskina and Strahan 2009)

8 Dell’Ariccia, Igan, and Laeven, “Lender Behavior During Credit Cycles” Specific remarks Own vs. competitors’ application growth –Denial rates decrease in own, increase in competitors’ application growth –Somewhat surprising – those probably increase 1-to-1 –Multicollinearity? –All banks are identical? (informed vs. uninformed) Loan performance? –Default rates, profit, stock prices… Lender behavior after problems became obvious to investors? –Currently data ends in 2006 –Could add 2007 to check how market specific conditions affected response to problems

9 Dell’Ariccia, Igan, and Laeven, “Lender Behavior During Credit Cycles” Just a thought Some more thinking needed on competition and entry –Higher approval rates not necessarily bad – informed vs. uninformed –How the rising approval rates relate to the decrease in market share of informed investors? –Compare approval rates in new markets vs. old markets –Entry into similar vs. different markets