Commercial Bank Failures During the Great Recession: The Real (Estate) Story

Abstract

In the presence of innovations in risk-transfer technology in mortgage markets, during the run-up to the 2007-08 crisis U.S. commercial banks significantly raised their exposure to non-household real estate credit. This was the primary driver of the subsequent failures. Though non-trivial, the direct impact of fragile funding structures was economically smaller, and so was that of private-label MBS, which affected large banks only. I find no evidence that traditional home mortgages and agency MBS contributed to the failures. Both failed and survivor banks underpriced real estate risk ex-ante. Failed banks’ investments suffered both from low industry and from low idiosyncratic returns, but the latter cannot be solely explained by differences in the pace of accumulation of real estate exposure during the run-up to the crisis.