Black Box, Greenleaf : Lender Behavior Under Uncertain Collateral Enforcement

This paper uses a shock to downside risk in contract enforcement to study lender behavior when collateral enforcement becomes uncertain. I exploit quasi-experimental variation from a shock legal judgement that increased enforcement costs on existing creditors but mechanically left new lenders unaffected. I estimate that the most exposed banks restricted lending by 21%, almost exclusively for portfolio loans. I provide evidence that this contraction in credit is not driven by balance sheet losses nor capital flight on the part of investors. Exploring the mechanism, I find that banks likely tightened lending standards following the judgement. Namely, exposed banks issued safer loans and denied high debt-to-income loan applications above the conforming loan limit. Furthermore, the salience of the shock increased in proximity to the judgement, size of the bank, and bank portfolio concentration. Lastly, following the judgement, I identify spillovers to other bank operations and the local economy. Small business lending increased in bank branch localities, house prices fell in the most exposed zip codes, and exposed counties experienced an increase in unemployment