Examining Bank Employee Compensation and Residential Mortgage Loan Volume at the State Level. International Journal of Business, Accounting, and Finance, 4(1), 18-32. (2010).
This study examines the impact of mortgage loan volume on bank employees’ total compensation at the state level. If banks had a stronger incentive to generate mortgage volume at the expense of credit quality in some state than others, and banks in these states responded by encouraging their employees to generate loan volume through employee compensation, then states with higher default rates will also have a stronger relationship between mortgage loan volume and employee compensation. This study finds that employees’ total compensation is positively related to mortgage loan volume. Examining across different states, this study finds that four states with the highest mortgage defaults, California, Nevada, Arizona, and Florida, have a higher sensitivity of total employee pay to mortgage loan volume, suggesting that employees were motivated to focus on volume rather than loan quality. More importantly, this study finds an increasing sensitivity of pay to mortgage volume that coincides with the housing market bubble period.
Government‑Sponsored Enterprises and Income Falsification on Mortgage Applications. International Journal of Business, Accounting and Finance, 8(1), 34-48. (2014).
This study examines income falsification on mortgage applications during the housing bubble using a measure of income falsification called “clusters.” The cluster measure is based on the tendency of people to pick similar numbers, including rounded numbers. Reported income on mortgage applications produced income clusters that rise and fall with house prices throughout the housing bubble. This study compares income clusters for loans concerning government- sponsored enterprises (GSEs), made by Fannie Mae and Freddie Mac that are just below the conforming loan limit, with jumbo loans just above the limit. By isolating a sample around the jumbo loan cutoff point, the results of this study find that the GSEs tend to have fewer clusters, suggesting that they suppressed income falsification. However, for a group of borrowers with very high reported income compared to area income, the GSEs have the highest clusters in the entire sample. This indicates that the greater paperwork requirements of borrowers by the GSEs may have reduced income falsification on most loans, while a very aggressive group of liars significantly inflated income, and possibly falsified documents, to receive subsidized GSE loans.
The Impact of Mortgage Loans Transferred on Bank Employee Compensation. Global Business & Finance Review, 14(1), 77-85. (2009).
This paper compares how employees are compensated when they originate loans that are held by the bank versus loans that are sold. Banks may be less concerned about the credit quality of a borrower when they sell the loan to an outsider. This study looks at mortgages transferred out of banks where partial recourse is transferred. First, it finds that loans transferred out of banks into Government Sponsored Enterprises (FNMA and FHLMC) and private entities increase employee compensation by 6 cents per dollar of loans transferred. Compared to the 3.5 cent increase in employee compensation per dollar of mortgage loans underwritten and held by the bank, this impact of mortgage loan transfers on compensation is about 71% higher. Thus, employees receive a stronger incentive to focus on loan volume and potentially focus less on credit quality, for those loans where liability for loss is being partially transferred away from the bank. This suggests that banks should review their compensation practices, and be prepared to communicate to regulators and investors who purchase loans about these practices. Regulators and investors may need to pay closer attention to the compensation policies of banks, and may even consider creating policies regarding the compensation of employees who originate not only mortgages, but any kind of loan that is being sold and securitized, or where recourse is being transferred.
Possible Evidence of Income falsification on Mortgage Application During The Housing Bubble. Journal of Business and Finance Research, 5(2), 5-28. (2015).
The purpose of this study is to investigate potential legal and regulatory triggers to the housing price run-up that occurred in the United States during recent years. We develop a new method to measure the incremental effect of governance on income falsification by focusing on problematic mortgage applications that had previously been denied. We find that Fannie Mae and Freddie Mac (the “Government Sponsored Enterprises: GSEs’) faced legal and regulatory pressure to satisfy underserved area requirements, which may have caused them to purchase mortgages with income falsification. These same pressures may have also encouraged securitizers to purchase mortgages with falsified income, for resale to the GSEs. Also, we find evidence that banks that wished to expand and were thus required to serve “community needs” had a similar effect. It was found that most regulators failed to prevent income falsification. These results suggest that more stringent requirements for mortgage originations are needed when lenders are being pressured to make loans. Greater regulatory oversight is needed in the mortgage market.
Was There a Regulatory Approval Market for Mortgages? Journal of Financial Economic Policy, 7(4), 354-365. (2015).
The purpose of this paper is to examine whether the underserved area requirements for Fannie Mae and Freddie Mac (the GSEs), and the community needs requirements of the Community Reinvestment Act (CRA) contributed to the house price run-up in the United States. This paper predicts the incidence of “Rebounds,” which indicate that a mortgage had been previously denied, in order to provide evidence on whether certain regulations caused excessively risky mortgage originations. Since a different lender rejected the loan given the interest rate that they were willing to charge and information on the borrower, a higher incidence of Rebounds provides evidence that lenders were more frequently disagreeing about loans. This can indicate differences in regulatory pressure or oversight across lenders. This paper provides evidence that the GSEs were purchasing fewer Rebounds directly from lenders. However, evidence suggests that indirectly, the securitization market served as a conduit for Rebounds to the GSEs that needed to satisfy regulatory underserved area requirements. The necessity of complying with the CRA was found to increase Rebounds. Among regulators, the Federal Reserve was found to have been particularly associated with Rebounds.
What Did Lenders Know? House Price Increases and Previously Rejected Mortgages. Journal of Accounting and Finance, 15(6), 9-16. (2015).
We examine whether the incidence of originated mortgages that had been previously denied by a different lender predicts house price increases in the United States from 2004-2006. Since these “Rebound” mortgages had been denied by a previous lender, it suggests that there was information available to lenders that the mortgages were excessively risky. We find that the incidence of Rebound mortgages was highest in Nevada, Florida, Arizona, and California. These four states had the highest default rates immediately after the housing market fell. In addition, the incidence of Rebounds predicts larger house price increases across major metropolitan statistical areas.
Joetta Forsyth, PhD, Associate Professor of Finance
Who Received TARP Bail-Outs? Did Widespread, Government-Detected Regulatory Filing Errors Predict Which Lenders Were Subsequently Bailed Out Under TARP?. Graziadio Business Review, 17(2). (2014).
Most mortgage lenders in the United States are required to report information on their mortgage applications to regulators under the Home Mortgage Disclosure Act (HMDA.) In 2006, at the height of the house price run-up, a surprisingly high number of filings had errors, as detected at the time and reported by the United States government. We find evidence that the incidence of these reported errors is related to potential overstated borrower income, among other factors associated with problematic lender behavior. Furthermore, lenders that had high levels of errors were more likely to get bailed out under the Troubled Asset Relief Program (TARP.) These findings suggest that the care that lenders take to fill out regulatory filings matters, and can predict trouble.