Negative Equity Research Articles

The impact of government ownership on bank risk

Abstract We use cross-country data on a sample of large European banks to evaluate the impact of government ownership on bank risk. We distinguish between default risk (likelihood of creditors’ losses) and operating risk (likelihood of negative equity). Our analysis is based on the joint use of issuer ratings, a synthetic measure of a bank’s probability of default, and individual ratings, which omit the influence of any external support and focus on a bank’s operating risk. We report two main results. First, government-owned banks (GOBs) have lower default risk but higher operating risk than private banks, indicating the presence of governmental protection that induces higher risk taking. Second, GOBs’ operating risk and governmental protection tend to increase in election years. These results are consistent with the idea that GOBs pursue political goals and have important policy implications for recently nationalized European banks.

Mobility and mortgages: Evidence from the PSID

We use the 1999–2009 Panel Survey of Income Dynamics to estimate household move probabilities as a function of, among other things, current housing equity. The lock-in effect supposes that mobility decreases with the mortgage loan-to-value ratio, particularly as equity becomes negative. We find that while owners do move less than renters, the move probability increases as homeowners become underwater. The propensity to move out of state in particular increases dramatically for sand state homeowners who have negative equity. There is no lock in effect from negative equity.

Three Proposals for Regulating the Distribution of Home Equity

The CFPB’s recently released “qualified mortgage” rules effectively discourage predatory lending but miss an equally important source of systemic risk: low-equity clustering. Specific “volatility inducing” mortgage terms when present in a substantial cluster of mortgage contracts exacerbate macroeconomic risk by increasing the chance that the housing and lending markets will have to absorb a wave of simultaneous defaults after a downturn in housing prices. We show that these terms became prevalent in a substantial proportion of residential mortgages in the years leading up to the home mortgage crisis. In contrast, during the earlier “amortization era” (when mortgagors were more likely to borrow at different times, with more substantial down payments, and more continual rates of amortization, without a need to refinance), an equally sized negative shock to housing prices would likely produce less negative equity, to a smaller set of borrowers. Instead of prohibiting the volatility-inducing terms, we propose three policies to better assure a greater diversification in the distribution of equity: (a) a modified home-mortgage interest deduction; (b) a modified “qualified residential mortgages” standard; and most importantly, (c) direct macroprudential regulation through a “cap-and-trade” system of leverage licenses and instituting varying degrees of “conforming mortgages” for Fannie Mae and Freddie Mac. Limiting the simultaneous clustering of negative equity mortgages can reproduce the structural advantages that were a natural byproduct of the amortization era where inevitable downturns, which disparately impacted homeowners with different levels of equity, could more easily be absorbed by the market.

The Principal Principle

AbstractI analyze optimal loan modification schemes in a stochastic home price and stochastic interest-rate environment. Lenders maximize loan values by managing the borrower’s option to default on the loan and prepayment option. Given negative equity, controlling for the borrower’s ability to pay, rate reductions and maturity extensions result in a higher probability of redefault by homeowners even after modification of their loans. In contrast, loan write-downs (the Principal Principle), not a favored recipe, are value maximizing for the lender. A shared-appreciation mortgage enhances the ability to pay, mitigates adverse selection, and reduces the present value of expected deadweight foreclosure costs.

Quantifying nation equity with sales data: A structural approach

Nation equity refers to a product's equity that is associated with its country of origin (COO). Generalized COO effects have previously been studied through experiments and surveys and measured by quality perception, product attitude, and purchase intention. We propose a structural equilibrium approach to assessing the additional market power COO offers, monetizing nation equity with product sales data, and computing the price premiums and discounts associated with nation equity. We apply this approach to China's personal computer market between 1995 and 2008 and find that COO does generate additional market power and affects firm markups. We find nation equity to be pervasive, significant, and multidimensional, and it evolves over time, but there is no simple correspondence between market share and nation equity. Large market shares do not necessarily mean positive nation equity and price premiums, negative nation equity and price discounts can evolve into positive nation equity and price premiums, and vice versa. We discuss the implications of our modeling approach and our findings for emerging markets in general, and for China in particular.

Are American homeowners locked into their houses? The impact of housing market conditions on state-to-state migration

U.S. policymakers are concerned that negative home equity arising from the housing market crash may be constraining geographic mobility and consequently serving as a factor in the persistently high national unemployment rate. Indeed, the widespread drop in house prices since 2007 has increased the share of homeowners who are underwater on their mortgages. At the same time, migration across states and among homeowners has fallen sharply. Using a logistic regression framework to analyze data from the Internal Revenue Service on state-to-state migration between 2006 and 2009, we discover evidence that “house lock” decreases mobility but find that it has a negligible impact on the national unemployment rate. A one-standard deviation increase in the share of underwater nonprime households in the origin state reduces the outflow of migrants from the origin to the destination state by 2.7%. When aggregated across the United States, this decrease in mobility reduces the national state-to-state migration rate by 0.05 percentage points, resulting in roughly 103,000 to 140,000 fewer individuals migrating across state lines in any given year. A back-of-the-envelope calculation shows that the impact of reduced mobility due to negative housing equity on the national unemployment rate is likely to be small—on the order of less than one-tenth of a percentage point each year.

Are American Homeowners Locked into Their Houses? The Impact of Housing Market Conditions on State-to-State Migration

U.S. policymakers are concerned that negative home equity arising from the severe housing market decline may be constraining geographic mobility and consequently serving as a factor in the nation’s persistently high unemployment rate. Indeed, the widespread drop in house prices since 2007 has increased the share of homeowners who are underwater on their mortgages. At the same time, migration across states and among homeowners has fallen sharply. Using a logistic regression framework to analyze data from the Internal Revenue Service on state-to-state migration between 2006 and 2009, the authors discover evidence that “house lock” decreases mobility but find it has a negligible impact on the national unemployment rate. A one-standard deviation increase in the share of underwater nonprime households in the origin state reduces the outflow of migrants from the origin to the destination state by 2.9 percent. When aggregated across the United States, this decrease in mobility reduces the national state-to-state migration rate by 0.05 percentage points, resulting in roughly 110,000 to 150,000 fewer individuals migrating across state lines in any given year. Assuming that all of these discouraged migrants were job-seekers who were previously unemployed before relocating and then found a job in their new state would reduce the nation’s unemployment rate by at most one-tenth of a percentage point in a given year. The cumulative effect over this period would yield an unemployment rate of 9.0 percent versus 9.3 percent in 2009. Recognizing that not all state-to-state migrants are job-seekers, not all job-seekers were previously unemployed, and not all previously unemployed job-seekers will successfully find work in their new location yields an unemployment rate that is virtually unchanged from the actual one that prevailed from 2006 to 2009.

Quantifying Nation Equity with Sales Data: A Structural Approach

Nation equity refers to a product's equity that is associated with its country of origin (COO). Generalized COO effects have previously been studied through experiments and surveys and measured by quality perception, product attitude, and purchase intention. We propose a structural equilibrium approach to assessing the additional market power COO offers, monetizing nation equity with product sales data, and computing the price premiums and discounts associated with nation equity. We apply this approach to China's personal computer market between 1995 and 2008 and find that COO does generate additional market power and affects firm markups. We find nation equity to be pervasive, significant, and multidimensional, and it evolves over time, but there is no simple correspondence between market share and nation equity. Large market shares do not necessarily mean positive nation equity and price premiums, negative nation equity and price discounts can evolve into positive nation equity and price premiums, and vice versa. We discuss the implications of our modeling approach and our findings for emerging markets in general, and for China in particular.

Impairment and negative equity in the Irish mortgage market

Amongst the many housing markets across the OECD presently experiencing difficulties, the Irish case stands out. Between 2004 and 2007, a significant house price bubble emerged in Ireland, while the real economy was enjoying persistently strong growth rates. The sharp decline in house prices post 2007 coupled with the significant increase in unemployment has generated a combination of difficulties for the Irish residential market. To date, much of the analysis and discussion of the Irish market has tended to focus on either the concept of mortgage repayment distress or potential negative equity. By examining the issue of credit default in the Irish mortgage market, we focus on the interaction between delinquency (repayment distress) and solvency (negative equity). Building on earlier work, which used the Survey on Income and Living Conditions (SILC), we marry existing estimates of repayment distress with estimates of negative equity for a representative sample of Irish households. Using copula modelling we then examine the dependence structure across the distributions of mortgage delinquency and solvency for these households. As a result, we are in a position to estimate the probability that a household experiencing repayment distress might also be in negative equity.

Political connection and leverage: Some Malaysian evidence

This paper extends prior work on the linkage between politically connected (PCON) firms and capital structure in developing countries. Specifically, this paper focuses on the association between Malaysian PCON firms and leverage, and is motivated by the results of Fraser et al. (2006) who report a positive association between leverage and political patronage. Controlling for a potential misspecification in that paper, this study documents that a significant proportion (almost 12%) of the Malaysian PCON firms have negative equity, and builds on the previous paper by providing fresh evidence that market to book ratio is positively associated with leverage, and that borrowing PCON firms have significantly lower ROA compared to non-PCON firms.

(Mis)use of State Law in Bankruptcy: The Hanging Paragraph Story

This article addresses the use of state law in bankruptcy in the context of the controversial “hanging paragraph” of the Bankruptcy Code, which was added to the Code by the 2005 amendments. The hanging paragraph appears to grant undersecured car lenders full payment in Chapter 13 bankruptcy cases, treatment that gives such lenders better treatment than other secured lenders. The provision is particularly controversial when applied to negative equity financing. Negative equity financing is provided by lenders when a car buyer offers a trade-in vehicle that is worth less than the outstanding loan that it secures. When a lender makes a negative equity loan, it is undersecured on the day the loan is made.Whether a negative equity loan is entitled to full payment under the hanging paragraph turns on the definition of “purchase money security interest,” a term that is used but not defined in the Bankruptcy Code. The majority of all courts that have addressed the issue, as well as all nine of the Circuit Courts of Appeal that have done so, considered the term to be defined by state law, relying on a 1979 Supreme Court case, Butner v. United States. In this Article, I explain why state law should not define the term purchase money security interest for hanging paragraph purposes.To do so, I propose a framework for analysis that is based on the difference between bankruptcy entry rights and bankruptcy exit rights to show that an analysis that relies only on Butner to determine the appropriate use of state law in bankruptcy is incomplete. This entry/exit framework requires a detailed examination of the package of rights inherent in any property interest in order to determine whether that right is one that bankruptcy policy should respect. I then explain that because a purchase money security interest in a consumer good (such as a car subject to the hanging paragraph) refers only to a bankruptcy exit right, it should be defined according to federal law, following another 1979 Supreme Court case, United States v. Kimbell Foods. I conclude by proposing a bankruptcy policy-based definition of purchase money security interest for hanging paragraph purposes.

The Environmental balance sheet of nations: reflections on global climate change scenarios

The objective of this work is to prepare environmental balance sheets of countries based on the scenarios for climate change and global warming indicated by the Intergovernmental Panel on Climate Change (IPCC)of the United Nations (UN). We consider the stock of forest resources and the residual balance between emission and capture of carbon or greenhouse gases (GHGs) estimated for each country in 2020 and 2050, according to the two editions (A1B1 and A2B2) of theSpecial Report on Emission Scenarios (SRES). The study is multidisciplinary in nature, involving concepts from the areas of climate change biology, energy, geoscience, economics and accounting. The last discipline was used to delineate the research subject and served as a method, by means of the Inquired Balance Sheet technique, to measure and classify environmental assets, liabilities and net equity. We selected a sample of seven countries, the four leading developing countries (Brazil, Russia, India and China – the BRICs) and one developed country each from the Americas, Europe and Asia (USA, Germany and Japan). The balance sheets of each country were calculated in equivalent gross domestic product (GDP) units, adjusted by per capita energy consumption in metric tons of oil equivalent (TOE) and megatons of carbon (MtonC), priced at the cost (in US$) of carbon credits suggested by the UN. The results show that the developed countries are consuming resources not only from other nations, but from future generations as well, and although Brazil and Russia have environmental surpluses, the consolidated balance sheet for the planet in the scenario for 2050 indicates a deficit or bankruptcy situation, with an “uncovered liability” or negative net equity of US$ 2,300 annually for each of the current 6.6 billion people (2008) and an environmental liability equivalent to a quarter of global GDP. This unconventional accounting report is a rendering or global accounts based on future scenarios and suggests the need for coordinated actions involving social, environmental, cultural and economic aspects.

What Actually Causes Mortgage Defaults, Redefaults, and Modifications

I use new household level data to simultaneously test three competing hypothesis about the primary cause of mortgage default. I consider the potential interactions of individual unemployment spells, negative equity, and unsecured debt. Unlike past studies that were only able to control for regional unemployment rates, I find that the double trigger event of job loss and negative equity is crucial in determining default as has been widely hypothesized in the literature. In every specification considered, the interaction term between unemployment and negative equity is significant indicating that double trigger events are the culprit in generating persistent defaults as hypothesized by Foote, Gerardi, and Willen (2009). I find that a person who has negative equity and who is unemployed is 10% more likely to default than a person who has just negative equity. The negative equity alone only makes a person 1.45% more likely to default, a factor of 6 smaller than the interaction probability. Unsecured debt plays a tertiary role compared to negative equity and unemployment, and past modifications make someone 20% more likely to have defaulted at the survey date. Redefaults, which are defaults after modification, are also well predicted by an interaction between unemployment and negative equity, and modifications are best predicted by past negative equity which makes someone 8% more likely to receive a modification.

Negative Equity Does Not Reduce Homeowners’ Mobility

Negative Equity Does Not Reduce Homeowners’ Mobility

Assessing Credit Risk in the RMBS Sector

U.S. residential mortgage performance is expected to remain under pressure in 2012. Although default rates and the number of serious delinquent loans have been falling, negative equity for non-agency RMBS loans continues to be a primary driver of collateral performance for all borrowers. RMBS credit risk can be measured by various quantitative measures of risk as an alternative to ratings.

Are We Out of the Woods Yet? Economic and Real Estate Markets in 2011

We seem to be basically moving sideways. The risk of a double dip recession is fading from summer highs, but growth is still elusive. The housing market itself is beset by headwinds. Specifically the persistence of negative equity and the shadow inventory are likely to drag down any gains in housing for a number of years. When housing will rise again will depend on the economy. <b>TOPICS:</b>Exchanges/markets/clearinghouses, information providers/credit ratings, financial crises and financial market history

Political connection and cost of debt: Some Malaysian evidence

This paper investigates the association between Malaysian politically connected (PCON) firms and the cost of debt. We extend previous research that finds Malaysian PCON firms are perceived as being of higher risk by the market, and by audit firms, by providing evidence that lenders also perceive these firms as being of higher risk. We also find that PCON firms have a significantly (1) higher extent of leverage, (2) higher likelihood of reporting a loss, (3) higher likelihood of having negative equity, and (4) higher likelihood of being audited by a big audit firm. We suggest that PCON firms are charged higher interest rates by lenders as a result of efficient contracting given their higher inherent risks. Additionally, we find that CEO duality present in PCON firms is perceived by lenders as being more risky, and that a higher proportion of independent directors on the audit committee mitigate this perceived risk.

Why is Price Discovery in Credit Default Swap Markets News-Specific?

Abstract: We analyse daily lead-lag patterns in US equity and credit default swap (CDS) returns. We first document that equity returns robustly lead CDS returns. However, we find that the CDSlag is due to common (and not firm-specific) news and arises predominantly in response to positive (instead of negative) equity market news. We provide an explanation for this newsspecific price discovery based on dealers in the CDS market exploiting their informational advantage vis-a-vis institutional investors with hedging demands. In support of this explanation we find that the CDS-lag and its news-specificity are related to various firm-level proxies for hedging demand in the cross-section as well measures for economy-wide informational asymmetries over time.

On the Incidence of a Financial Transactions Tax in a Model with Fire Sales

This paper studies the impact of a financial transactions tax on a financial market where financial institutions trade with each other. Assets are marked to the market and financial institutions with negative equity are forced out of business. There are two main results: First, if all banks have enough liquidity so that they can honor their short-term obligations, a financial transactions tax is entirely neutral. Second, in a model with correlated investment risk and short-term financing of banks, a financial transactions tax contributes to financial distress and undoes other policy measures that are used to stabilize financial markets.

Why is Price Discovery in Credit Default Swap Markets News-Specific?

We analyse daily lead-lag patterns in US equity and credit default swap (CDS) returns. We first document that equity returns robustly lead CDS returns. However, we find that the CDS-lag is due to common (and not firm-specific) news and arises predominantly in response to positive (instead of negative) equity market news. We provide an explanation for this news-specific price discovery based on dealers in the CDS market exploiting their informational advantage vis-a-vis institutional investors with hedging demands. In support of this explanation we find that the CDS-lag and its news-specificity are related to various firm-level proxies for hedging demand in the cross-section as well measures for economy-wide informational asymmetries over time. Keywords: credit default swap, price discovery, informational efficiency, hedging demand JEL codes: G12, G15, G21