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Economic Research

Liberty Street Economics
At the New York Fed: Conference on the Effects of Post-Crisis Banking Reforms
On Friday, June 22, the New York Fed will host a conference featuring staff research regarding the efficacy of the wave of regulatory reforms enacted following the financial crisis and ensuing recession. Have the banking reforms achieved their intended goals and have there possibly been unintended consequences?
By Richard Crump and João Santos
Hey, Economist! Outgoing New York Fed President Bill Dudley on FOMC Preparation and Thinking Like an Economist
New York Fed President Bill Dudley will soon turn over the keys to the vault—so to speak.  But before his tenure in office ends on June 17, Liberty Street Economics sought to capture some of his reflections on economic research, FOMC preparation, and leadership. Publications editor Trevor Delaney recently caught up with Dudley.
Just Released: New York Fed Press Briefing Highlights Changes in Home Equity and How It’s Used
At a press briefing, economists at the New York Fed focused on the evolution of housing wealth and its use as collateral. Their comments came in connection with the Center for Microeconomic Data’s release of its Quarterly Report on Household Debt and Credit for the first quarter of 2018.
By Andrew Haughwout, Donghoon Lee, Joelle Scally, and Wilbert van der Klaauw
Forecasts of the Lost Recovery
Our bloggers review the findings of their recent working paper that documents the real-time forecasting performance of the New York Fed dynamic stochastic general equilibrium (DSGE) model in the wake of the Great Recession. They show that the model’s predictive accuracy was on par with that of private forecasters and, in terms of GDP growth, proved to be quite a bit better than the median forecasts from the Federal Open Market Committee’s Summary of Economic Projections.
By Michael Cai, Marco Del Negro, Marc Giannoni, Abhi Gupta, and Pearl Li
Have the Biggest U.S. Banks Become Less Complex?
Although the organizational, business, and geographic complexity of the largest U.S. bank holding companies (BHCs) has declined somewhat since the global financial crisis, these institutions remain highly complex.  Our bloggers’ findings underscore the importance of regulatory frameworks that continue to focus on limiting the risk of failure of these BHCs and on improving resolution mechanisms for dealing with these institutions in the event of failure.
By Linda S. Goldberg and April Meehl
Recent Publications
Resolving “Too Big to Fail”
Following the 2008 financial crisis, the Dodd-Frank Act mandated that each large and complex financial institution file a “living will” that details how it could unwind positions when distressed, without significant systemic impact. Using a synthetic control research design, the authors find that living-will regulation increases a bank’s annual cost of capital by 22 basis points, or 10 percent of total funding costs. The authors interpret their findings as a reduction in “too big to fail” subsidies.
By Nicola Cetorelli and James Traina, Staff Reports 859, June 2018
Bank-Intermediated Arbitrage
In the aftermath of the financial crisis, a number of asset markets have experienced large, persistent deviations from the law of one price—that the same exposure to the same source of risk should be priced the same no matter how that exposure is achieved. The authors argue that these deviations persist because of limits-to-arbitrage engendered by post-crisis regulatory and market structure changes that have increased the cost of participation in spread-narrowing trades for regulated institutions.
By Nina Boyarchenko, Thomas M. Eisenbach, Pooja Gupta, Or Shachar, and Peter Van Tassel, Staff Reports 858, June 2018
Does CFPB Oversight Crimp Credit?
The authors study the effects of regulatory oversight by the Consumer Financial Protection Bureau (CFPB) on credit supply as well as bank risk taking, growth, and operating costs. They find little evidence that CFPB oversight significantly reduces the overall volume of mortgage lending. However, their analysis does yield some evidence of changes in the composition of lending—CFPB-supervised banks originated fewer loans to risky borrowers, offset by an increase in “jumbo" mortgages. The authors find no clear evidence that CFPB oversight induced lower asset growth or higher expenses.
By Andreas Fuster, Matthew Plosser, and James Vickery, Staff Reports 857, June 2018
Leverage Limits and Bank Risk: New Evidence on an Old Question
Using difference-in-difference analysis, the authors find that after the supplementary leverage ratio (SLR) was finalized in 2014, the very largest U.S. banks shifted their portfolio toward riskier (risk-weighted) assets and higher-yielding securities than did large banks not subject to the rule. Despite increased asset risk, overall bank risk (book and market measures) did not increase, suggesting the higher capital required under the new rule offset the risk shifting.
By Dong Beom Choi, Michael R. Holcomb, and Donald P. Morgan, Staff Reports 856, June 2018
Why Do Banks Target ROE?
This paper considers why banks emphasize return on equity (ROE) as a performance metric while non-financial firms tend to measure their performance based on earnings per share (EPS). The authors cite two reasons why the industry adopted an ROE target: 1) increasing competition in the banking industry from nonbank financial institutions since the 1970s and a liberalization of intra-state and inter-state bank branching restrictions, and 2) the fact that banks benefit from government deposit insurance, which the authors argue was not fairly priced.
By George Pennacchi and João A. C. Santos, Staff Reports 855, June 2018
Regulatory Changes and the Cost of Capital for Banks
The authors estimate the cost of capital for the banking industry and explore how it has changed over time. They find that while the cost of capital soared for banks during the financial crisis, after the passage of the Dodd-Frank Act, the value-weighted cost of capital for banks fell differentially more than did the cost of capital for nonbanks. They also find some evidence that stress testing has lowered the cost of capital for the largest stress-tested banks.
By Anna Kovner and Peter Van Tassel, Staff Reports 854, June 2018
The Cost of Bank Regulatory Capital
The Basel I Accord required banks to set aside capital when they extended commitments with maturities in excess of one year, but short-term commitments were not subject to a capital requirement. The Basel II Accord sought to reduce this discontinuity by extending capital standards to short-term commitments. The authors use these differences in capital standards around one-year maturity to infer the cost of bank regulatory capital.
By Matthew C. Plosser and João A. C. Santos, Staff Reports 853, June 2018
Bank Liquidity Provision and Basel Liquidity Regulations
The authors examine liquidity creation per unit of assets by banks subject to the Liquidity Coverage Ratio (LCR) using the liquidity measures Liquidity Mismatch Index (Bai et al. 2018) and BB (Berger and Bouwman 2009). Among their findings, since 2013, there has been reduced liquidity creation by LCR banks compared with non-LCR banks, occurring mostly through greater holdings of liquid assets and lower holdings of illiquid assets.
By Daniel Roberts, Asani Sarkar, and Or Shachar, Staff Reports 852, June 2018
Trends in Credit Basis Spreads
Market participants and policymakers were surprised by the large, prolonged dislocations in credit market basis trades during the second half of 2015 and the first quarter of 2016. The authors examine three proposed explanations: increased idiosyncratic risks, strategic positioning by asset managers, and regulatory changes. They find that, given current levels of regulatory leverage, the credit default swap–bond basis needs to be significantly more negative than its pre-crisis levels to achieve the same ROE target.
By Nina Boyarchenko, Pooja Gupta, Nick Steele, and Jacqueline Yen, Economic Policy Review, Forthcoming
Regulation and Risk Shuffling in Bank Securities Portfolios
There is an incomplete understanding of how the use of fair values for regulation affects the incentives and behavior of financial institutions. This paper studies the effects of a recent policy change that ties regulatory capital directly to the market value of the “available-for-sale” investment securities portfolios. The authors find little clear evidence that banks respond by reducing the riskiness of their securities portfolios. Instead, banks respond by reclassifying securities to mitigate the effects of the policy change.
By Andreas Fuster and James Vickery, Staff Reports 851, June 2018
Changing Risk-Return Profiles
Are stock returns predictable? The authors address this question by modeling the predictive density as a function of economic and financial variables and assessing the accuracy of the associated forecasts. Their main finding is that realized volatility, especially of financial sector stock returns, has strong predictive content for the future distribution of returns. Focusing on the volatility of bank equity as the financial condition most relevant to broad market risk, the authors conclude that recent regulatory reforms are associated with an improvement in risk.
By Richard K. Crump, Domenico Giannone, and Sean Hundtofte, Staff Reports 850, June 2018
Negative Swap Spreads
Market participants have been surprised by the decline of U.S. interest rate swap rates relative to Treasury yields of equal maturity over the past two years. Interest rate swap spreads became negative for many maturities. The authors’ analysis suggests that, given the balance sheet costs, these spreads must reach more negative levels to generate an adequate return on equity for dealers. This may represent a shift in the spread levels considered attractive for trading, suggesting there may be a “new normal” level at which dealers are incentivized to trade.
By Nina Boyarchenko, Pooja Gupta, Nick Steele, and Jacqueline Yen, Economic Policy Review, Forthcoming