New Research On The Impact Of Financial Deregulation Catches The Eye Of The Federal Reserve

Columbia Business School professor spots unforeseen signs of deregulation and will present findings to the Fed during upcoming conference in October

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Columbia Business School

Sep 24, 2014, 11:00 ET

NEW YORK, Sept. 24, 2014 /PRNewswire/ -- As the US slowly emerges from the Great Recession, policymakers are still debating what needs to be done to make the financial system more stable and secure. While countless theories and studies continue to debate the effect that deregulation has on the crises and what actions are necessary to prevent another financial catastrophe, a new study released today from Columbia Business School identifies ways to spot the unforeseen signs of deregulation and build a near-crisis-proof economy in the future.

The results of the study will be presented to the Federal Reserve in a series of meetings this fall. The findings are expected to help policymakers understand the underlying problems with deregulation, which could help determine the tools necessary for a financially stable world.

"Many experts blame the crisis on laxer lending standards and higher-risk mortgage products," says Marco Di Maggio, assistant professor of finance and economics at Columbia Business School. "In reality national banks and the mortgage deregulation of early 2000s plays a pivotal role in triggering the subprime crisis. While regulators might try to shift the blame, our research shows they were actually a big part of the problem to begin with."

The research, titled "Credit-Induced Boom and Bust," is co-authored by Marco Di Maggio of Columbia Business School and Amir Kermani of the University of California at Berkeley. It explores how the deregulation of state laws that restricted lending to riskier borrowers falsely inflated the market and later caused the financial crisis.

Researchers concluded that national banks, which were preempted by federal regulations in 2004, increased the issuance of riskier loans by 15% during the period 2004-2006, which resulted in a 20% increase in house prices followed by a collapse of similar magnitude in the following years, and in a 45% increase in delinquency rates in counties with a higher concentration of national banks. This evidence shows how the effort to promote homeownership by low-income households has significantly contributed to the subprime lending crisis. These clear banking effects of deregulation could help The Fed foresee issues when supervising and revising banking laws.

These results and more will be presented and expanded upon during an October 7-8 conference on "Monetary Policy and Financial Stability" organized by the Federal Reserve Banks of Atlanta and Cleveland, The Bank of Canada, and the Swiss National Bank (SNB). Additionally, the authors will lay out their findings and recommendations at the New York Federal Reserve on November 12.

The Research

The paper examines the impact had on banks that trumped anti predatory laws in 2004, which resulted in credit expansion that enabled national banks to grant credit to riskier borrowers.

The authors reviewed changes in mortgage origination, home values, employment, and delinquencies trends between counties with a different concentration of national banks and assessed the impacts of the credit supply on the real economy.

Researchers concluded that national banks benefiting from the deregulation produced an increase in lending to riskier borrowers, which inflated housing prices and increased delinquency rates, generating the observed boom and bust pattern in many sectors of the economy. Ironically, the same low-income households, who regulators tried to help, were disproportionally more affected by the national banks' predatory behavior.

To learn more about the cutting-edge research being conducted at Columbia Business School, please visit www.gsb.columbia.edu.

About Columbia Business School

Columbia Business School is the only world-class, Ivy League business school that delivers a learning experience where academic excellence meets with real-time exposure to the pulse of global business. Led by Dean Glenn Hubbard, the School's transformative curriculum bridges academic theory with unparalleled exposure to real-world business practice, equipping students with an entrepreneurial mindset that allows them to recognize, capture, and create opportunity in any business environment. The thought leadership of the School's faculty and staff, combined with the accomplishments of its distinguished alumni and position in the center of global business, means that the School's efforts have an immediate, measurable impact on the forces shaping business every day. To learn more about Columbia Business School's position at the very center of business, please visit www.gsb.columbia.edu.

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