Thrifty Viability and Traditional Mortgage Lending: A Simultaneous Equations Analysis of the Risk-Return Trade-Off

M. Cary Collins (), Van Son Lai and James E. McNulty ()
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M. Cary Collins: Department of Finance 421 Stokely Management Center College of Business Administration The University of Tennessee Knoxville, Tennessee 37996, http://bus.utk.edu/finance/default.html
James E. McNulty: Department of Finance and Real Estate College of Business PO Box 3091 Florida Atlantic University Boca Raton, Florida 33431-0991, http://www.collegeofbusiness.fau.edu/

Journal of Real Estate Research, 1997, vol. 13, issue 2, 155-176

Abstract: A number of studies have argued that the thrift industry is not viable as it is presently structured and regulated because mortgage yields are inadequate to cover interest and operating costs. This hypothesis suggests that observed profitability is primarily the result of the tendency of the industry to "ride" the yield curve by borrowing short and lending long. To evaluate this argument, we construct a simultaneous-equations model of thrift risk (maturity gap positions) and return (net interest margin). We find support for the notion that the industry could not be reasonably profitable if it did not take on significant interest-rate risk. For instance, a zero gap position produces a return on assets of only 19 basis points and a return on equity of only 4%. We also estimate the amount of interest-rate risk the industry can employ to increase returns on equity and assets. Our estimates show that over 50% of thrift profits earned during this period are the result of negative gap positions and interest-rate speculation. As earlier research shows, changes in regulations affecting thrift asset and liability choices can be counterproductive.

JEL-codes: L85 (search for similar items in EconPapers)
Date: 1997
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