The main test sample used in previous chapters excludes the top-five securitizing BHCs, namely Bank of America, Citigroup, JPMorgan Chase, Wells Fargo, and Countrywide Financial. Countrywide was one of the largest mortgage lenders in the U.S. until Bank of America acquired it in 2008. Countrywide was a BHC only over the period 2001-2006, prior to which and immediately after, it was a “Domestic Entity Other”, an institution type that is not required to file FR-YC.1 The top-five BHCs are among the largest and most complex
BHCs in terms of total assets. They rank in the top 20 banks by assets throughout my sample period 1993-2015. As of December 31, 2017, JPMorgan Chase, Bank of America, Wells Fargo, and Citigroup were the top four BHCs with total assets of $2.53 trillions, $2.38 trillions, $1.95 trillions, and $1.84 trillions, respectively. In comparison, the fifth- ranked BHC Goldman Sachs has $0.916 trillions in total assets, half of the fourth-ranked Citigroup.
Figure6.1 presents the time series plot of the total outstanding amount of securitized mortgages as reported in FR-Y9C for all BHCs, for the top-five BHCs, and for non-top-five BHCs in my sample. The figure shows that the top-five BHCs as a group dominate the mortgage securitization market, particularly after 2001. While the scale in figure6.1makes it difficult to see, the top-five BHCs do not dominate the securitization market prior to 2001 in a similar manner. Their combined outstanding securitized mortgages range from a low 40% in 1998 to a high 91% in 2008, as a proportion of total outstanding securitized mortgages for all BHCs in my sample.
1As defined by the FFIEC, the Domestic Entity Other category contains “domestic institutions that en- gage in banking activities usually in connection with the business of banking in the United States”. https: //www.ffiec.gov/nicpubweb/content/help/institution%20type%20description.htm accessed April 16, 2018.
Figure 6.1: Outstanding Securitized Mortgages
This figure presents a time series plot of total outstanding securitized mortgages over the period
1993-2015 by all BHCs filing FR-Y9C (solid blue line), by the five BHCs excluded from the main sample (dashed orange line), and by BHCs in the main sample (dotted gray line).
These BHCs are also responsible for large jumps in securitization activity in 2001, 2007 and 2008. The total amount of outstanding securitized mortgages jumped significantly in 2001. A large proportion of this jump is due to increases in reported securitization by the top-five BHCs, which are also responsible for the large changes in 2007 and in 2008. The large jump in securitization volume in 2001 mostly happened in quarters 2-4 of 2001, immediately after FAS 140 became effective in the second quarter of 2001 (i.e for securitizations that occurred after March 31, 2001).
It is possible some of the increase in securitization volume was driven by the new reporting regulatory standards that accompanied FAS 140, which may have forced BHCs to report previously undisclosed securitization. However, I manually checked the annual
reports of the top-five BHCs in 2001, and I find that the jump is mostly driven by new securitization by the top-five BHCs during the last three quarters of 2001. For instance, Securitized mortgages reported on FR Y9C by Bank of America increased by $60 billion from 2000 to 2001. Bank of America reports in its 2001 annual report to shareholders that “During the fourth quarter of 2001, $17.5 billion of subprime loans were securitized and retained in the available-for-sale securities portfolio” (p. 88), and that it “converted a total of $52.9 billion of residential first mortgages into mortgage-backed securities issued through Fannie Mae, Freddie Mac, Ginnie Mae and Bank of America Mortgage Securities” (p.95). In its annual reports, Citi discloses new mortgage securitizations of approximately $12 billion and $24 billion in 2000 and 2001, respectively. The majority of Citi’s securitizations were issued in quarters 2-4 of 2001. Citi’s quarterly report for the first quarter of 2001 discloses only $4 billion in mortgage securitization. Consistent with a significant increase in new securitizations after FAS 140 became effective, Chernenko, Hanson & Sunderam
(2013) document a sharp rise in new non-prime mortgage securitization in 2001Q4 and thereafter.
Countrywide became a BHC in 2001, adding its stock of mortgage securitizations of $287 billions, including $103 billions in new securitization, to the FR Y9C database. Coun- trywide is responsible for the drop in 2007 as it reverted to the category Domestic Entity Other, dropping out of the FR Y-9C database. The large increase in 2008 can also be explained by activities related to the same institution. Bank of America acquired Coun- trywide in 2008, which led to the re-inclusion of its securitized assets in the FR Y-9C database.
An alternative explanation for this jump in reported securitization is the change in the operating definition of recourse for regulatory reporting. It is possible that securitizing BHCs did not consider credit enhancements as risk retention in the pre-FAS 140 period, resulting in unreported securitizations in the period. This would result in a jump in the post-FAS 140 period, when credit enhancements are explicitly included in the definition of risk retention. In the pre-FAS 140 period, the form Y-9C requires BHCs to report assets sold with recourse, which are defined as assets “transferred with recourse or some other form of risk retention by the bank holding company or a consolidated subsidiary in transactions reported as sales in accordance with generally accepted accounting prin- ciples.” [emphasis added] (Instructions for Preparation of Consolidated Financial State- ments for Bank Holding Companies: Reporting Form FR Y-9C, March 1999, p.HC-F-5) In contrast, in the post-FAS 140 period, the form Y-9C requires BHCs to report “assets sold and securitized withservicing retained or with recourse or other seller-provided credit enhancements.”[emphasis added] (Instructions for Preparation of Consolidated Financial Statements for Bank Holding Companies: Reporting Form FR Y-9C, March 2001, p.HC-
S-2) The instruction also provides a detailed definition of ‘recourse or other seller-provided credit enhancements’.
The top-five securitizing BHCs are also among the banks that are considered too-big-to- fail (TBTF). Prior literature examines the effect of these guarantees on bank risk-taking. The TBTF practice goes back to at least the 1950s where regulators bailed out large failing U.S. banks (e.g., Hetzel 1991, Prescott, Nurisso et al. 2017), and continues to the present day with the more recent episode involving the bailouts during the financial crisis in the late 2000’s (e.g., Bordo 2008).2 The expectation that banks will be bailed out reduces creditors’ and investors’ incentives to monitor banks, dampening market discipline and potentially leading to greater bank risk-taking.
This TBTF problem is similar to the agency problem that arises from deposit insurance, which reduces insured depositors’ incentive to monitor bank risk-taking. Merton (1977),
Goldberg & Hudgins (2002), Hovakimian, Kane & Laeven (2003), and Nier & Baumann
(2006), among others study the effect of deposit insurance on bank risk-taking though its effect on depositors’ monitoring incentives. While these agency problems may exist without deposit insurance or even in non-bank firms, deposit insurance exacerbates the inherent moral hazard problem in the banking industry. Merton(1977) provides a theoretical foun- dation for the above argument that deposit insurance can reduce depositor monitoring and lead to greater bank risk-taking. Hovakimian et al. (2003) argue that deposit insurance leads to risk shifting where insured banks take more risk at the expense of the insuring party, i.e., the Federal Deposit Insurance Corporation (FDIC). Demirg¨u¸c-Kunt & Detra- giache (2002), Hovakimian et al. (2003), and Laeven & Levine (2009) provide empirical evidence that shows deposit insurance leads to greater bank risk-taking.
Similarly, explicit and implicit guarantees afforded to TBTF banks can result in even greater moral hazard problems whereby these banking institutions take greater risk. Dam & Koetter (2012) examine a sample of German banks over the 1995-2006 period, and they show that higher bailout expectation leads to greater bank risk-taking. Duchin & Sosyura (2014) examine banks that applied to get assistance from the Troubled Asset Relief Program (TARP), and they find that bailed-out banks increased their risk-taking in the same asset classes that led to the need for the bailout in the first place.
In general, the literature provides both theoretical and empirical support that expec- tations and realizations of bailouts lead to greater bank risk-taking. As a result, it is
2A detailed description of the bank bailout during the crisis, through the Troubled Assets Relief Pro- gram (TARP), including the list of TARP recipients and the amount they received, is available on the U.S. Treasury Department’s websitehttps://www.treasury.gov/initiatives/financial-stability/ TARP-Programs/bank-investment-programs/Pages/default.aspx
reasonable to expect that the top-five BHC have greater incentive to take more risk than most of the other BHCs in the main sample because they are among the most likely banks to be bailed out. The fact that these five BHCs dominate the mortgage securitization market makes them interesting to explore further. Their response to transparency changes can be different from the other BHCs because they have different risk-taking incentives and because they are large and more complex institutions that may be operating differently than the other BHCs.