Vikrant Vig

Securitization and Distressed Loan Renegotiation: Evidence from the Subprime Mortgage Crisis

We examine whether securitization impacts renegotiation decisions of loan servicers, focusing on their decision to foreclose a delinquent loan. Conditional on a loan becoming seriously delinquent, we find a significantly lower foreclosure rate associated with bank-held loans when compared to similar securitized loans: across various specifications and origination vintages, the foreclosure rate of delinquent bank-held loans is 3% to 7% lower in absolute terms (13% to 32% in relative terms). There is a substantial heterogeneity in these effects with large effects among borrowers with better credit quality and small effects among lower quality borrowers. A quasi-experiment that exploits a plausibly exogenous variation in securitization status of a delinquent loan confirms these results.

The Failure of Models that Predict Failure: Distance, Incentives and Defaults

Statistical default models, widely used to assess default risk, fail to account for a change in the relations between different variables resulting from an underlying change in agent behavior. We demonstrate this phenomenon using data on securitized subprime mortgages issued in the period 1997–2006. As the level of securitization increases, lenders have an incentive to originate loans that rate high based on characteristics that are reported to investors, even if other unreported variables imply a lower borrower quality. Consistent with this behavior, we find that over time lenders set interest rates only on the basis of variables that are reported to investors, ignoring other credit-relevant information. As a result, among borrowers with similar reported characteristics, over time the set that receives loans becomes worse along the unreported information dimension. This change in lender behavior alters the data generating process by transforming the mapping from observables to loan defaults. To illustrate this effect, we show that the interest rate on a loan becomes a worse predictor of default as securitization increases. Moreover, a statistical default model estimated in a low securitization period breaks down in a high securitization period in a systematic manner: it underpredicts defaults among borrowers for whom soft information is more valuable. Regulations that rely on such models to assess default risk could, therefore, be undermined by the actions of market participants.

Access to Collateral and Corporate Debt Structure: Evidence from a Natural Experiment

We investigate how firms respond to strengthening of creditor rights by examining their financial decisions following a securitization reform in India. We find that the reform led to a reduction in secured debt, total debt, debt maturity, asset growth and an increase in liquidity hoarding by firms. Moreover, the effects are more pronounced for firms that have a higher proportion of tangible assets, since these firms are more affected by the secured transactions law. These results suggest that strengthening of creditor rights introduces a liquidation bias and documents how firms alter their debt structures to contract around it.

The Limits of Model-Based Regulation

In this paper, we investigate how the introduction of complex, model-based capital regulation affected credit risk of financial institutions. Model-based regulation was meant to enhance the stability of the financial sector by making capital charges more sensitive to risk. Exploiting the staggered introduction of the model-based approach in Germany and the richness of our loan-level data set, we show that (1) internal risk estimates employed for regulatory purposes systematically underpredict actual default rates by 0.5 to 1 percentage points; (2) both default rates and loss rates are higher for loans that were originated under the model-based approach, while corresponding risk-weights are significantly lower; and (3) interest rates are higher for loans originated under the model-based approach, suggesting that banks were aware of the higher risk associated with these loans and priced them accordingly. Further, we document that large banks benefited from the reform as they experienced a reduction in capital charges and consequently expanded their lending at the expense of smaller banks that did not introduce the model-based approach. Counter to the stated objectives, the introduction of complex regulation adversely affected the credit risk of financial institutions. Overall, our results highlight the pitfalls of complex regulation and suggest that simpler rules may increase the efficacy of financial regulation.

Rent-seeking in elite networks

We employ a unique data set on members of an elite service club in Germany to investigate how social connections in elite networks affect the allocation of resources. Specifically, we investigate credit allocation decisions of banks to firms inside the network. Using a quasi-experimental research design, we document misallocation of bank credit inside the network, with bankers with weakly aligned incentives engaging most actively in crony lending. Our findings, thus, resonate with existing theories of elite networks as rent extractive coalitions that stifle economic prosperity.

The Unintended Effects of the Sarbanes-Oxley Act

The Sarbanes-Oxley Act (SOX) was passed in the wake of several scandals that rocked corporate America in 2001 and 2002. The objective behind SOX was to improve corporate governance by improving accounting disclosures. Compliance with Section 404 is considered by many to be the most costly requirement of SOX and has been argued to be a disproportionate burden for small firms. Consequently, firms with a public float below

On estimating the distribution of optimal traveling salesman tour lengths using heuristics

75 million were granted several exemptions from compliance. We document an unintended effect of these exemptions: a weakening of corporate governance through a weakening of the market for corporate control.

The Privatization of Bankruptcy: Evidence from Financial Distress in the Shipping Industry

The traveling salesman problem is an important combinatorial optimization problem due to its significance in academic research and its real world applications. The problem has been extensively studied and much is known about its polyhedral structure and algorithms for exact and heuristic solutions. While most work is concentrated on solving the deterministic version of the problem, there also has been some research on the stochastic TSP. Research on the stochastic TSP has concentrated on asymptotic properties and estimation of the TSP-constant. Not much is, however, known about the probability distribution of the optimal tour length. In this paper, we present some empirical results based on Monte Carlo simulations for the symmetric Euclidean and Rectilinear TSPs. We derive regression equations for predicting the first four moments of the distribution of estimated TSP tour lengths using heuristics. We then show that a Beta distribution gives excellent fits for small to moderate sized TSP problems. We derive regression equations for predicting the parameters of the Beta distribution. Finally we predict the TSP constant using two alternative approaches.

Leveraged Buyouts and Credit Spreads

We study the resolution of financial distress in shipping, where the ex-territorial nature of assets has distanced the industry from on-shore bankruptcy legislation. We demonstrate how contracts and private institutions have adapted to the industry’s special circumstances so as to deliver an effective resolution of financial distress. We investigate three costs of distress: coordination failures leading to the arrest of ships, the direct costs of arrest and auction, and the fire sale discount. We find that most arrests are not caused by coordination failures but rather are precipitated by debtors whose equity is far out of the money and where the ships are close to their break up values. The direct costs of arrest and auction are 8% of a vessel’s value, and there is an average fire sale discount of 26%. However, when we control for the low quality of such ships (due to under-maintenance), their low value, and corrupt versus non corrupt ports, the discount virtually disappears. The results suggest that bankruptcy laws that are justified by coordination failures between creditors and large fire sale discounts, may not be necessary, at least for some industries.

Financial Regulation and Securitization: Evidence from Subprime Loans

This paper studies the impact of LBO restructuring risk on corporate credit spreads. Using an extensive dataset of LBOs, CDSs and bonds, we first study the reaction of credit spreads of target firms to LBO announcements in the US during the years 2001-2015. We find that CDS spreads increase by almost 60% for investment grade bonds and we document a significant negative reaction in the prices of corporate bonds. We then proceed to show that LBO risk is priced ex-ante by investors in debt markets. Results of a panel regression imply that firms more likely to undergo an LBO have significantly higher spreads. Moreover, we show that intra-industry CDS spreads increase in response to an LBO announcement, consistent with investors updating the probability of future LBOs when an LBO occurs. Based on this empirical evidence, we propose an extended structural Merton (1974) model incorporating LBO risk to study the impact on credit spreads over time and across maturities. Model estimation implies an increase of 30-35 bps in credit spreads due to LBO risk in periods with high LBO activity. The average contribution of LBO risk to credit spreads is as high as 15 bps at a 10-year maturity.