David S. Scharfstein
Edmund Cogswell Converse Professor of Finance and Banking
David S. Scharfstein is the Edmund Cogswell Converse Professor of Finance and Banking at Harvard Business School. His research focuses on banking, financial distress, risk management, housing finance, venture capital and corporate investment. He teaches the introductory finance course in the MBA program and the Ph.D. corporate finance course. Previously, he has taught courses on private equity and venture capital.
Prior to joining the Harvard Business School faculty in 2003, Scharfstein was for 16 years on the finance faculty of MIT's Sloan School of Management, most recently as the Dai Ichi Kangyo Professor of Management. He has been Editor of the Rand Journal of Economics, Associate Editor of the Journal of Finance and Review of Financial Studies, and Director of the American Finance Association. He has received fellowships from the Sloan Foundation, Batterymarch Financial Management, and the Olin Foundation, as well as a Fulbright Scholarship at Oxford University.
Scharfstein is a Research Associate of the National Bureau of Economic Research. He is also a member of the Squam Lake Working Group on Financial Regulation, a nonpartisan, nonaffiliated group of fifteen leading economists which offers guidance on financial regulatory reform and recently published The Squam Lake Report: Fixing the Financial System (Princeton University Press). During 2009-10 Scharfstein served as Senior Advisor to the Secretary of the U.S. Treasury.
Scharfstein has a Ph.D in Economics from MIT (1986) and an A.B. summa cum laude from Princeton University (1982).
The Growth of FInance
The U.S. financial services industry grew from 4.9% of GDP in 1980 to 7.9% of GDP in 2007. A sizeable portion of the growth can be explained by rising asset management fees, which in turn were driven by increases in the valuation of tradable assets, particularly equity. Another important factor was growth in fees associated with an expansion in household credit, particularly for residential mortgages. This expansion was itself fueled by the development of non-bank credit intermediation (or "shadow banking"). Whether the growth of the financial sector has been socially beneficial depends on one's view of active asset management, the increase in household credit, and the growth of shadow banking. While recognizing some of the benefits of professional asset management, we are skeptical about the marginal value of active asset management. We then raise concerns about whether the potential benefits of increased access to household credit—the main output of the shadow banking system—are outweighed by the risks inherent in this new approach to credit delivery.
Concentration in Mortgage Lending, Refinancing Activity, and Mortgage Rates
We present evidence that high concentration in local mortgage lending reduces the sensitivity of mortgage rates and refinancing activity to mortgage-backed security (MBS) yields. A decrease in MBS yields is typically associated with greater refinancing activity and lower rates on new mortgages. However, this effect is dampened in counties with concentrated mortgage markets. We isolate the direct effect of mortgage market concentration and rule out alternative explanations based on borrower, loan, and collateral characteristics in two ways. First, we use a matching procedure to compare high- and low-concentration counties that are very similar on observable characteristics and find similar results. Second, we examine counties where concentration in mortgage lending is increased by bank mergers. We show that within a given county, sensitivites to MBS yields decrease after a concentration-increasing merger. Our results suggest that the strength of the housing channel of monetary policy transmission varies in both the time series and the cross section. In the cross section, increasing concentration by one standard deviation reduces the overall impact of a decline in MBS yields by approximately 50%. In the time series, a decrease in MBS yields today has a 40% smaller effect on the average county than it would have had in the 1990s because of higher concentration today.
Dollar Funding and the Lending Behavior of Global Banks
A large share of dollar-denominated lending is done by non-U.S. banks, particularly European banks. We present a model in which such banks cut dollar lending more than euro lending in response to a shock to their credit quality. Because these banks rely on wholesale dollar funding, while raising more of their euro funding through insured retail deposits, the shock leads to a greater withdrawal of dollar funding. Banks can borrow in euros and swap into dollars to make up for the dollar shortfall, but this may lead to violations of covered interest parity (CIP) when there is limited capital to take the other side of the swap trade. In this case, synthetic dollar borrowing becomes expensive, which causes cuts in dollar lending. We test the model in the context of the Eurozone sovereign crisis, which escalated in the second half of 2011 and resulted in U.S. money-market funds sharply reducing the funding provided to European banks. Coincident with the contraction in dollar funding, there were significant violations of euro-dollar CIP. Moreover, dollar lending by Eurozone banks fell relative to their euro lending in both the U.S. and Europe; this was not the case for U.S. global banks. Finally, European banks that were more reliant on money funds experienced bigger declines in dollar lending.
An Evaluation of Money Market Fund Reform Proposals
We analyze the leading reform proposals to address the structural vulnerabilities of money market mutual funds (MMFs). We take the main goal of MMF reform to be safeguarding financial stability. Specifically, MMF reforms should reduce the ex ante incentives for MMFs to take excessive risks and increase the ex post resilience of MMFs to system-wide runs. We argue that requiring MMFs to have capital buffers best accomplishes these goals. Capital provides MMFs with loss absorption capacity, lowering the probability that a MMF suffers losses large enough to trigger a run, and
reduces ex ante incentives to take excessive risks. Using a methodology that is standard in bank capital regulation, we estimate that a capital buffer of 3% to 4% would reduce the probability of breaking the buck to 0.1%, the threshold commonly used in bank capital models. The riskiness of this capital buffer would be comparable to the riskiness of the long-term debt of an A-rated or BBBrated financial firm. This implies that MMF capital would earn roughly 1.25% more than riskless short-term debt and MMF shareholders would earn 0.05% less in exchange for the protection provided by this capital. In summary, capital buffers would yield significant financial stability benefits, while maintaining the current fixed net asset value (NAV) structure of MMFs. Other leading reform alternatives such as converting MMFs to a floating NAV will be less effective in safeguarding financial stability. In practice, MMFs with a floating NAV would have all of the same vulnerabilities as MMFs have today. Introducing floating NAVs would not alter incentives for risk taking nor would it reduce incentives to run—investors would still attempt to exit early before illiquid assets have to be sold. Thus, we suggest that regulators adopt capital buffers for MMFs.