Deregulation, Competition and the Race to the Bottom

Abstract

We exploit the OCC's preemption of national banks from state laws against preda- tory lending as a quasi-experiment to study the eect of deregulation and its inter- action with competition on the supply of complex mortgages (prepayment penalties, interest-only, and negative amortization). Following the preemption ruling, national banks signi…cantly increased their origination of loans with prepayment penalties and negative amortization features by comparison with lenders not regulated by OCC and lenders in states without predatory lending laws. Further, we highlight a competi- tion channel: in counties where OCC-regulated lenders had larger market shares prior to the preemption, even non-OCC lenders responded by increasing their use of these riskier terms to the extent permitted by the state predatory-lending laws. Overall, our evidence suggests that the deregulation of credit markets triggered a race to the bottomamong distressed …nancial institutions, working through competition between lenders.