Why Did Financial Institutions Sell RMBS at Fire Sale Prices during the Financial Crisis?

Craig B. Merrill, Taylor Nadauld and Shane Sherlund ()
Additional contact information
Craig B. Merrill: Brigham Young University
Taylor Nadauld: Brigham Young University

Working Paper Series from Ohio State University, Charles A. Dice Center for Research in Financial Economics

Abstract: Much attention has been paid to the large decreases in value of non-agency residential mortgage-backed securities (RMBS) during the financial crisis. Many observers have argued that the fall in prices was partly caused by fire sales. We use capital requirements and accounting rules to identify circumstances where financial institutions had incentives to engage in fire sales and then examine whether such sales occurred. For financial institutions subject to credit-sensitive capital requirements, capital requirements increase as an asset's credit becomes impaired. When accounting rules require such an asset's value to be marked-to-market and the fair value loss to be recognized in earnings, a capital-constrained firm can improve its capital position by selling the credit-impaired asset even if it has to accept a liquidity discount to do so. In contrast, a financial firm whose fair value losses are not recognized in earnings for the purpose of calculating capital requirements is more likely to satisfy capital requirements by selling liquid assets whose value has not fallen and hence would be unlikely to engage in fire sales. Using a sample of 5,000 repeat transactions of non-agency RMBS by insurance companies from 2006 to 2009, we show that insurance companies that became more capital-constrained because of operating losses (uncorrelated with RMBS credit quality) and also recognized fair value losses sold comparable RMBS at much lower prices than other insurance companies during the crisis.

JEL-codes: G01 G21 G22 G23 M41 (search for similar items in EconPapers)
Date: 2013-02
New Economics Papers: this item is included in nep-ban and nep-fmk
References: Add references at CitEc
Citations: View citations in EconPapers (2)

Downloads: (external link)
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2212684

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:ecl:ohidic:2013-02

Access Statistics for this paper

More papers in Working Paper Series from Ohio State University, Charles A. Dice Center for Research in Financial Economics Contact information at EDIRC.
Bibliographic data for series maintained by ().