Bank structure and mortgage rates: a comment

JBCO BUSN

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Bank Structure and Mortgage Rates: a Comment Timothy J. Curry and John T. Rose

In a recent article in this journal, Marlow (1982) estimates a structure-performance model of the mortgage loan market. Marlow bases his analysis on effective rates charged on conventional mortgages du,-ing 1975 by major mortgage lenders in 111 SMSAs. ~ In alternative specifications of his model, he finds a statistically significant relationship between mortgage rates and market structure, using three conventional measures of market structure--the number of firms, the three-firm concentration ratio, and the five-firm concentration ratio (Equations (1), (3), and (4) in Table 1 of Marlow's article). He also reports a significant relationship for two out of three other measures of market structure, which he tests in separate specifications (Equations (2), (5), and (6) in Marlow's Table 1). Despite these impressive results, Marlow's empirical work involving the use of concentration ratios--the most general and commonly used of his measures of market structure--is flawed. Marlow correctly emphasizes the importance of including all the major mortgage-lending firms in measuring market performance and structure, and, indeed, his perfo~mance measure is so constructed. However, he inconsistently measures finn concentration in terms of commercial banks alone. 2 He justifies this spec:iEcation on the ~grounds that commercial banks "... are typically the largest depository institution in any SMSA" (p. 138). But even if correct, this argument ~pplies only to the numerator of the concentration ratio and ignores the importance of nonbank mortgage lenders, namely, thrift institutions and mortgage companies, (o the base or de-

Marlow's sample is taken from a list of 160 SMSAs for which mortgage surv-.y dat~ were compiled by' tl~e Federal Home Loan Bank Board for the period 1967-1978; see lhl~nfeldt a~d McKenzie (1979). For each SMSA, a weighted average of effective ratc,~ and terms cha gad on conventional rsongages by commercial banks, savinl~s and loan associations, mutual savings banks, and mortt~age companies is listed nuaUy for the survey period. 2 That Mariow met~sures market coacentra:ion in terms of commercial banks is ,,vidr~tt from the text (p. 138) as well as from footnote 16, which gives the source of his concentration data, Slsmmary of Deoos/ts and Accounts (1974, 1975), pres,enting market share information for commercit, t hanks alone. By (ontrast, Marlow measur-.s the number c~ff i r ~ s in the market--the structure measure us, 'd it, Equation (1) iit hi:; Tab~'e l - - a s well as mJrket deposits and growth in terms of all mortgage-lending de~,ository institutions. Timothy J. Curr), is .an Economist v,ith the Division of Research and Statistics, Board of Go~ernorr .~,',he Fede~ral Reserve System. John T. Rose is Senic~r Economist, Di~'ision of Rese~ ch and Statistics, Board ofGo, rernors of the Fede:-a! Reserve System. Address reprint requests to John 7. Rose, Division ~ f Research and Star istic,,, Boartl of Governors of t he Federa~l Reser~ e System, Washington, D.C. 20.¢51.

Journal of Economics and Business, 36, 283-287(1984) © 1984 Temple University

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T.J. Curry and J. T. Rose nominator of this market structure, measure. To the extent that such nonbank lenders account for a sizable percentage of the morgage lending in an SMSA, then a concentra1 tion ratio that ignores their presence in the denorr:ir~ato; will overstate the level of concentration of the !ocal mortgage market. Furthermc ~e, unless the business accounted for by such nonbank lenders is distributed across SM',]As in proportion to that of commercial banks, the relative levels of concentration across markets will also be distorted by focusing on commercial banks alone. Another potential problem relates to the fact that Marlow does not consolidate bank subsidiaries of multibank holding companies in computing commercial bank concentration data. (The publication from which he obtains his market share data to compute concentretion ratios gives the market shares of unconsolidatea banks only.) To the extent that bank holding companies operate as integrated, single entities (like branch banks), it would seem appropriate to consolidate holding company subsidiaries for pvrposes of measuring banking market structure. In that regard, survey evidence indicates that most holding companies do centralize the management ¢,f their subsidiaries, at least to some degree, and that the extent of centralization within holding companies h~s generally increased over the past decade. 3 Further, bank regulators typically consolidate holding company" subsidiaries for purposes of analyzing the competitive effects of bank mergers and bank holding company acquisitions. 4 The objective of this comment is to reestimate for 1975 those specifications of Mariow's model that rely on concentration ratios as the market structure measure (Equations (3) and (4) in his Table I ), including in the measurement of market concentration 1) all the major suppliers for which individual firm data are available on a market basis and 2) the consolidation of bank subsidiaries of multibank holding companies. 5 Reestimates of Marlow's Equation (3), which uses a three-firm concentration ratio, are presented in our Table 1. Reestimates of his Equation (4), which uses a fivefirm concentration ratio, yielded results similar to those for Equation (3~ and so are not shown. Equation ~1) in our Table I presents the results (with one independent variable deleted) given by Marlow for Equation (3) in his article. Equation (2) is an attempted replication of Marlow's results to verify his estimates. In both equations, market concentration (CO3) i,~ measured in terms of total deposits ofcotttmercial banks (unconsolidated for multibank holding companies), which is the measure used by Marlow. Equation (3) is a reestimate of Equation (2) based on market concentration measured in terms of total deposits for all mortgage-lending depository institutions, namely, commercial banks, mt, tual savings banks, and savings and loan associations (CO3A). 6 Fi-

' For a review, of the early literature in this area, see Rose (1978). More recent evidence is provided by the Association of Bank Holding Companies (1978) and Whalen ( 1981-- 1982). ' A cursory re,, Jew of the literature revealed that most structure-performanct, studies in '~anking make no mention cffthe con:;oli4ation issue, nor do they give any information as to whether ho!ding company subsidiaries are consolidated. However, in personal discussions, the authors of several of the published studies in the area indicate that they routinely consolidate. '~ One could also take issue with the general specification of Ma~ iow's model. For example, he fails to account for intermarket differences in wage costs, which may have an impertant influence on loan prices. Stnce the objective of this comment is simply ~o demonstrate the effect of correcting the measurement of the concentration variable, no attempt was nmde to respecify the general model. " The ~deal :.~pproach to measuring firm concentration in the mortgage market would b to use total m;~rtgage originations of all mortgage-Iending institutions, including mortg;,ge companies. - second-best technique might be to use total mortgage loans on thc i3ooks of all mortgage lending institutions, or even all mortgage-lending depository institutions. Data limitations, however, preclude any of these approaches.

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T.J. Curry and J. T. Rose

nally, Equations (4) and (5) are reestimates of Equations (2) and (3), respectively, with market shares of subsidiaries of multibank holding companies ~:onsolidated. The independent variable that was included in Marlow's model but deleted in the estimated equations presented here is the foreclosure rate for 1975 (FOR). Foreclosure data were not readily available, and the foreclosure vz~'iable is significant in only one of Mar!ow's two specifications that incorporated a concentration-ratio measure of market structure, and then only at the 90% level using a one-tail test. 7 The sample used in Equations (2)-(5) includes 113 SMSAs for which a complete set of data could be obtained, s Market total deposits, deposit growth, and concentration were computed from Summary of Deposit informatio::. * All other variables, except the population variables, were taken from the Federal Home Loan Bank Board survey data on mortgage loans and terms used by Marlow. Population data were compiled from the Statistical A bstract o f the United States ( 1976, 1977). Looking first at Equation (2), which is an attempted replication of Marlow's Equation (3) (presented as our Equation (1)), the results are nearly identical, despite the exclusion of the foreclosure variable. All the significant coefficients in our Equation (l) are nearly duplicated in Equation (2), with similar t-statistics in both equations. The R 2 is also very similar in both equations. Results for our Equation (3) indic,~te a mcaiest improvement by measuring market c~,ncentration in terms of all mortgage-lending depository institutions. ~0Both the coefficient and '~he significance ievel of the three-firm concentration ratio are slightly higher i~:~our Equation (3) than in Equation (2), along with the R 2. nt The fact that the results are not improved further may be attributed to the relatively high correlation between CO3 and CO3A; the simple correlation coefficient (r) between these two measures is 0.864. Results for Equations (4) and (5), which are reestimates of Equations (2) and (3) with bank market .,;hares consolidated foL- multibank holding companies, show a similar pattern with respect to the inclusion of thrifts in the cor, centration ratio. Specifically, the results indicate a small increase in the coefficient and significance level of market concentration, as well as a slight increase in the R 2, in Equation (5) relative to Equation (4). Taken together with the results for Equations (2) and (3), these findings confirm

To the extent that FOR is correlated with other independent variables, it might still have an insignificant cc-efficient, yet its exclusion from the model could affect the remaining coefficients. As indicated in the text below, however, the exclusion of FOR has little effect on the coefficients of the other variables. For a discussion of the omission of a relevant explanatory variable, see Kmenta (I 971). As rioted earlier, Marlow's sample includes ! I 1 S M S A s Both samples are dr. wn from a list of 160 SMSAs for which mortgage rate data are available. Most of the deleted SMSAs in our sample are excluded because of t.he lack or population dlata. Marlow gives no additional inforulation about his sample selection procedure. "Sumrnary of Deposit data are taken from Summary o f Savings Accounts b.v Geographic Area ( 1974, 1975) and Summary of Deposit tapes. J0 Including thrift institutions not only affects the denominator of the concentration ratio in every instance, but also the numerator in many cases, contrary to Mariow's assumption that thrifts arc rarely the largest depository institution in an SMSA. Of the total sample of 1 ! 3 markets, 57 had at least one thrift institution large ee,ougt', to be included among the three largest mortgage-lending depository institutions (unadjusted for multibank holding corr:pany affiliations) in tl',t market in 1975. As a result of these changes the average three-firm concentration ratio for the 113 markets declines from 60.8% in Equation (2) to 43.6% in Equation (3). , s In relative terms, the coefficient of the three-firm concentration ratio jumps sharply in Equation (3) from its level in Equation (2). How~.'ver, the absolute increase is small, and the size off.he coefficient is small in both equation,,. The resuitr~ for t-quation (3) indicate that a 10 percentage point increase in CO3A would increase the average effective con~centlonal mortgage rate by only 5 basis points.

Bank Stucture anc~ Mc, rtga[ ~ Rates: Comment

287

our criticism of Marlow's work for not t',~ing into account the nonbank lenders in measuring concentration within loca! mortgage markets. P~t the same time, the results indicate only a slight improvement in the -mpirlcal findin~.s as a result of this correction. Perhaps more noteworthy are the results for Equations (4) and (5) relative to those for Equations (2) and (3), respectively. As shown, both the coefficient and significance level of the concentration variable decline slightly, along w~.th the R 2, in response to the consolidation of bank subsidiaries of muitibank holding companies. Two possible e Kplanations are apparent. First, the assumption that multiba~k holding companics op~ :rate as integrated, single entities may be erroneous, at iea~t during the period of this study, whictl was still fairly early in the history -ff the maltibank holdit~g company movement. Second, even if muitibank holding companies do operate as consolidated organiz:~dons, competitors may not immediately perceive them as such, at least during the tormative years of the holding company movement. In either case. the observed structural changes associated with the multibank holding company movement of the early 1970s may have been too recent to affect market performance in 1975. Both possibilities provide interesting theses for future research, z2

We wish to thank Alan J. Daskin and John D. Wolken for helpful comments. We also extend thanks to Randall Brown and Elizabeth Gordon for research assistance. The view." expressed are those of the authors and do not necessarily reflect the views of the Board or its staff.

References Association of Bank Holds ng Companies. Feb. 1978. Bank Holding Company Centrorization Policies. Prepared by Golembe Associates, Inc. Encaoua, D., and Jacque d n , A. 1982. Organizational efficiency and monopoly power: The case of French industrial [ roups. European Economic Review 19:25-51. lhlanfeidt, K. R., and McKenzie, J. A. Nov. 1979. Metropolitan area mortgage rates and terms 1967-1978. Research Working Paper #87. Washington, D.C.: Federal Home Loan Ban~ Board. Kmenta, J. 1971. Elemen:s o f Econometrics. New York: Macmillan. Marlow, M. L. 1982. Bank atructure and mortgage rates: Implications for interstate banki ~g. Journal o f Economics and Busine is 34:135-142. Rose, J. T. Sept. 1978. Bank holding companies as operational single entities. In The B,:nk Holding Company Movement to 1978: A Compendium. Washington, D.C.: Board cf Governors of the Federal Reserve Sestem, pp. 69-93. StatisticalAbstract o f the United St~tes. 1976 and 1977. Washington, D.C.: U.S. Bureau of the Census. Summary o f Deposits and Accounts', 1974 and 1975. Washington, D.C.: Federal Deposit Insurance Corporation. Summary o f Savings Accounts by Geographic Area. 1974 and 1975. Washington, D.C. : Federal Home Loan Bank Board. Whalen, G. Winter 1981-1982. Operational policies of multibank holding companies. Economic Review. Federal Reserve Bank of Cleveland, pp. 20-31.

~2A recent stud:v hy Eacaoua lnd Jacquemi~ (1982) of French indust:tal groups also ret: ~rts a stronger structure-performance relations hip when concentrat ion is measured in terms of legally distinct companies ,han when it is measured in term:; of consolidated organizations.