David Scharfstein is the Edmund Cogswell Converse Professor of Finance and Banking at Harvard Business School, where he is also Senior Associate Dean, Doctoral Programs. Scharfstein has published on a broad range of topics in finance, including corporate investment and financing behavior, risk management, financial distress, capital allocation, and venture capital. His current research focuses on financial intermediation and financial regulation, including research on housing finance, financial system risk, bank lending and funding, and the growth of the financial sector. Scharfstein is currently a research associate of the National Bureau of Economic Research. During 2017, he was president of the American Finance Association and now serves on its board. In 2009-2010, he was a senior advisor to the U.S. Treasury Secretary. He previously was a member of the Financial Advisory Roundtable of the Federal Reserve Bank of New York. From 1987- 2003 he was a finance professor at the MIT Sloan School of Management. Scharfstein received a Ph.D. in Economics from MIT in 1986 and an A.B. from Princeton University in 1982.
This paper examines the effect of pension policy on the structure of financial systems around the world. In particular, I explore the hypothesis that policies that promote pension savings also promote the development of capital markets. I present a model that endogenizes the extent to which savings are intermediated through banks or capital markets, and derive implications for corporate finance, household finance, banking, and the size of the financial sector. I then present a number of facts that are broadly consistent with the theory and examine a variety of alternative explanations of my findings.
We argue that stock market pressure to generate earnings encourages banks to increase risk. We measure risk using confidential supervisory ratings as well as financial information released in regulatory filings. We document that there is an increase in the risk-taking behavior of banks that become part of publicly traded bank holding companies (BHCs) either through a public listing (IPO) or acquisition by a publicly-traded BHC. This increase in risk is greater than the increase in risk for a control group of banks that intended a private-to-public transition through an IPO or acquisition, but where the deal failed. This finding is robust to instrumenting deal failure with an index of stock returns shortly after deal announcement. There are a number of explanations of this finding, but cross-sectional and time-series evidence points to stock-market earnings pressure. In particular, we find that the relative increase in risk by banks that transition to being publicly held is more pronounced if they have good governance, consistent with the idea that stock-price maximization underlies the incentive to take risk. We also find more pronounced effects in periods when the Fed funds rate and credit spreads are low. This finding is consistent with the idea that when there is downward pressure on bank earnings, publicly-held banks tend to increase risk more than privately-held banks.
We present evidence that high concentration in mortgage lending reduces the sensitivity of mortgage rates and refinancing activity to mortgage-backed security (MBS) yields. We isolate the direct effect of concentration and rule out alternative explanations 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 bank mergers increase concentration in mortgage lending. Within a county, sensitivities 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, the overall impact of a decline in MBS yields is only 42% as large in a high-concentration county as it is in an average one. In the time series, a decrease in MBS yields today has a 32% smaller effect on the average county than it would have had in the 1990s because of higher concentration today.
This paper proposes a new approach to social cost-benefit analysis using a model in which a benevolent government chooses risky projects in the presence of market failures and tax distortions. The government internalizes market failures and therefore perceives project payoffs differently than do individual private actors. This gives it a "social risk management" motive - projects that generate social benefits are attractive, particularly if those benefits are realized in bad economic states. However, because of tax distortions, government financing is costly, creating a "fiscal risk management" motive. Government projects that require large tax-financed outlays are unattractive, particularly if those outlays tend to occur in bad economic times. At the optimum, the government trades off its social and fiscal risk management motives. Frictions in government financing create interdependence between two otherwise unrelated government projects. As in the theory of portfolio choice, the fiscal risk of a project depends on how its fiscal costs covary with the fiscal costs of the government's overall portfolio of projects. This interdependence means that individual projects should not be evaluated in isolation.
U.S. money market mutual funds (MMFs) are an important source of dollar funding for global financial institutions, particularly those headquartered outside the U.S. MMFs proved to be a source of considerable instability during the financial crisis of 2007–2009, resulting in extraordinary government support to help stabilize the funding of global financial institutions. In light of the problems that emerged during the crisis, a number of MMF reforms have been proposed, which we analyze in this paper. We assume that the main goal of MMF reform is safeguarding global financial stability. In light of this goal, reforms should reduce the ex ante incentives for MMFs to take excessive risk and increase the ex post resilience of MMFs to system-wide runs. Our analysis suggests that requiring MMFs to have subordinated capital buffers could generate significant financial stability benefits. Subordinated capital provides MMFs with loss absorption capacity, lowering the probability than an MMF suffers losses large enough to trigger a run, and reduces incentives to take excessive risks. Other reform alternatives based on market forces, such as converting MMFs to a floating NAV, may be less effective in protecting financial stability. Our analysis sheds light on the fundamental tensions inherent in regulating the shadow banking system.
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.
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.
