Why Did U.S. Banks Invest in Highly-Rated Securitization Tranches?
We estimate holdings of highly-rated tranches of mortgage securitizations of American deposit-taking banks ahead of the credit crisis and evaluate hypotheses that have been advanced to explain these holdings. We find that holdings of highly-rated tranches were economically trivial for the typical bank, but banks with greater holdings performed more poorly during the crisis. Though univariate comparisons show that banks with large trading books had greater holdings, the holdings of highly-rated tranches are not higher for banks with large trading books in regressions that control for bank size. The ratio of highly-rated tranches holdings to assets increases with bank assets, but not for banks with more than $50 billion of assets. This evidence is inconsistent with explanations for holdings of highly-rated tranches that emphasize the incentives of banks deemed "too-big-to-fail". Further, the evidence does not provide support for "bad incentives" theories of holdings of highly-rated tranches. We find, however, that banks active in securitization held more highly-rated tranches. Such a result can be consistent with regulatory arbitrage as well as with securitizing banks holding highly-rated tranches to convince investors of the quality of these securities. Our evidence supports the latter hypothesis.
Respectively, assistant professor, Fisher College of Business, Ohio State University, assistant professor, Brigham Young University, and Everett D. Reese Chair of Banking and Monetary Economics, Fisher College of Business, Ohio State University, NBER, and ECGI. We are grateful to John Sedunov for research assistance and to Viral Acharya, Philip Strahan, George Pennachi, and Michael Weisbach for useful comments. René Stulz has been and is involved in compensated activities, including expert testimony, on behalf of large financial institutions related to the securities studied in this paper. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.
“Why Did Holdings of High - Rated Securitization Tranches Differ So Much Across Banks?” with Isil Erel and Taylor Nadauld, The Review of Financial Studies, 2014, v27(2), 404-453.