Lewis J. Spellman

Repudiation Risk and Restitution Costs: Toward Understanding Premiums on Insured Deposits

This paper contains a theoretical development of the relationship of CD premiums to both the risks of the CD issuer and the third party government guarantor of those deposits. The theoretical development shows that the risk of the guarantor derives from the possibility that the guarantee could be repudiated and/or the restitution of the depositors claim could be costly. The empirical analysis of the premiums for insured CDs indicates that during the years preceding the ultimate collapse of the FSLIC, the market priced the risk of both the guarantor as well as the firm. The guarantor risk pricing was responsive to the insolvency of the guarantor, the attempts to recapitalize the guarantor and the efforts to resolve the insolvent thrifts. During this eventful time period CD premiums rose to 187 basis points and averaged 79 and 54 basis points. Copyright 1994 by Ohio State University Press.

The impact of rental properties on the value of single-family residences

Abstract This study examines the effects that single-family rental properties in a residential neighborhood have on the value of single-family residences in that area. The analysis blends real estate valuation concepts with evidence found in the housing maintenance literature and urban succession theory to develop testable hypotheses regarding the property-specific, proximity-related, and neighborhood-wide impacts of rental properties on property values. The data used to test the hypotheses include the tenure status of 23,119 single-family residences and 1,162 single-family sales. Regression results support all three hypotheses. Although numerous studies on the value impacts of other externalities have been published, this is the first study to examine the separation of property rights. The results of this study provide additional insights into housing maintenance and also have implications for neighborhood zoning regulations.

Lender Certification Premiums

The announcement of a bank loan by a borrowing firm has been shown to have a positive effect on the market value of the borrowers claims. This is consistent with a lenders implied endorsement of the borrower - an endorsement that has value to the borrower. In this paper, we investigate whether the lender is able to extract a premium loan rate or certification premium in return. We find empirical evidence that in the absence of collateral reputable lenders are able to exact a certification premium.

Firm and Guarantor Risk, Risk Contagion and the Interfirm Spread Among Insured Deposits

We develop a model of third party guaranteed debt and show that interest rate premiums are multiplicatively related to firm and guarantor risk. We apply the model to thrifts issuing CDs guaranteed by the FSLIC and then estimate firm probabilities of insolvency and guarantor risk across 20 observed months. This time period spans the insolvency of the guarantor followed by two recapitalizations. The relative stability in firm risk across time offers no evidence of generalized risk contagion among firms. We attribute elevated CD premiums and rate spreads to increases in guarantor risk rather than changes in firm risk.

Subordinated debt prices and forward-looking estimates of bank asset volatility

Abstract We have estimated the forward-looking bank asset volatility using market prices of bank equity and subordinated debt. This is in contrast to estimation procedures which rely on historical stock price volatilities. Important for bank regulatory policy, we find that, during 1987–1988, a time of financial stress in the banking industry, most bank asset volatility estimates based on contemporaneous market information were on average 40% higher than historically-based readings. Our results suggest that elevated asset volatilities would require higher risk-based capital standards to protect the deposit guarantor.

Inflation and Housing Prices

Home ownership is a claim on the stream of net rents. Like any income-producing asset, the market capitalizes its value. The price-rent multiple depends upon the expected growth rate of revenues and expenses, on financing terms, and on taxes. This paper derives this price-rent multiple in terms of these variables and calculates its value from 1963 through 1978.The results indicate that housing prices grew more rapidly than rents and the CPI largely as the result of a 33% increase in the price-rent multiple over those years. This increase in the capitalization rate occurred, despite higher nominal financing terms, because the relative terms of housing finance tended to ease and because the expected growth rate of rents increased more than its discount rate. Copyright American Real Estate and Urban Economics Association.

Investment Income and Non-Life Insurance Pricing

The purpose of the paper is to develop a microeconomic theory of a non-life insurance firm in order to derive the profit maximizing price for its intangible product. It is shown that the economic theory of the insurance firm resembles both the theory of the production firm and the theory of the financial intermediary. Moreover, the profit maximizing price for the insurer is found to be one which reflects the marginal revenues and marginal costs associated with both underwriting and financial intermediary activities of the firm. The purpose of this paper is to develop an economic theory of the nonlife insurance firm. A firm which underwrites insurance displays many of the features of the typical production firm since it receives current premium revenues to cover current costs of underwriting. In addition, since the insurer holds a portfolio of earning assets, it displays many of the features of the typical financial intermediary. Given this mixture of operations, the insurer arrives at a profit maximizing price by taking into account the marginal revenues and marginal costs associated with both its underwriting and financial intermediary activities. The first section of this paper specifies the basic assumptions underlying the model of the profit maximizing insurer. Next, the cash balance decision of the insurer as a financial intermediary is discussed. Finally, the profit maximizing price is derived in terms of the marginal costs of underwriting and financial intermediation, given the competitive conditions of the insurance market. In this latter section, the insurers price derived from a profit maximizing procedure also is compared to a price based upon a mark-up of average costs. The Model

Bank forbearance: A market-based explanation

Abstract Why does forbearance for insolvent banks occur? We offer an explanation based on stockholders’ ability to appeal to the courts for reversal and monetary damages after the regulator has initiated a receivership action. Although this has always been theoretically possible, precedents and common law standards now exist. We calculate the market’s perceived postponement of receiverships for banks thought to be insolvent. We explain the receivership delays with the regulator’s reluctance to proceed when investors’ pricing of the bank’s stock and accountants’ assessment of the bank’s solvency do not support a receivership action. Our clinical evidence is consistent with this notion. Jel Classification: G180; G200; G210; G280