Self-fulfilling Runs: Evidence from the US Life Insurance Industry

Transcription

1 Carnegie Mellon University Research CMU Society for Economic Measurement Annual Conference 2015 Paris Jul 22nd, 2:30 PM - 4:30 PM Self-fulfilling Runs: Evidence from the US Life Insurance Industry Stephane Verani Board of Governors, U.S. Federal Reserve, stephane.h.verani@frb.gov Nathan Foley-Fisher Board of Governors, U.S. Federal Reserve, nathan.c.foley-fisher@frb.gov Borghan Narajabad Board of Governors, U.S. Federal Reserve, borghan.narajabad@frb.gov Follow this and additional works at: Part of the Economics Commons Stephane Verani, Nathan Foley-Fisher, and Borghan Narajabad, "Self-fulfilling Runs: Evidence from the US Life Insurance Industry" (July 22, 2015). Society for Economic Measurement Annual Conference. Paper This Event is brought to you for free and open access by the Conferences and Events at Research CMU. It has been accepted for inclusion in Society for Economic Measurement Annual Conference by an authorized administrator of Research CMU. For more information, please contact research-showcase@andrew.cmu.edu.

2 Self-Fulfilling Runs: Evidence from the U.S. Life Insurance Industry Nathan Foley-Fisher Borghan Narajabad Stéphane Verani Federal Reserve Board SEM-Paris July 2015 The views expressed in this paper do not necessarily reflect the views of the Board of Governors of the Federal Reserve System, or its staff

3 Question Is shadow banking vulnerable to self-fulfilling runs? Empirical challenge is to tease out the self-fulfilling component May affect different links in the financial intermediation chain Could originate or amplify shocks

4 Financial Intermediation and Runs Traditional banking: Assets Credit cards Auto loans Mortgages Liabilities Deposits claim cash Shadow banking (example): ABCP Conduit Money Market MF Assets Liabilities Assets Liabilities Credit cards Auto loans Mortgages Asset-backed CP CP share Asset-backed cash CP Cash cash

5 This paper Studies a run by institutional investors on U.S. Life insurers Exploits the contractual structure of their short-term securities Finds evidence of a self-fulfilling component to the run Coincident to runs on ABCP and repo by the same investors

6 How did life insurers become part of shadow banking? Life insurers became part of shadow banking when traditional business became less profitable (Foley-Fisher, Narajabad, Verani 2015b) Life Insurance Company SPV Assets Liabilities Assets Liabilities Mortgages Private label ABS Corporates Funding Agreement Annuity payment cash Funding Agreement FABS Notes to investors cash Funding agreements are insurance obligations The U.S. FABS market peaked at over $160 billion in 2007 market balance sheet FABS can be issued under various terms and with put options to meet demand from different types of institutional investors

7 Extentible FABS: Runs Extendible FABS are put-able FABS designed for MMFs From 2007Q3, institutional investors refused to extend XFABS

8 Extendible FABS: Prospectus MetLife $800 million note issued on June 6, 2011 Maturity Date: Initial Maturity Date: July 6, 2012, or, if such day is not a Business Day, the immediately preceding Business Day, except for those Extendible Notes the maturity of which is extended on the initial Election Date in accordance with the procedures described under Extendible Notes below. Extended Maturity Dates: If a holder of any Extendible Notes does not make an election to extend the maturity of all or any portion of the principal p amount of such holder s Extendible Notes during the notice period for any Election Date, the principal p amount of the Extendible Notes for which such holder has failed to make such an election will become due and py payable on any later date to which the maturity of such holder s Extendible Notes has been extended as of the immediately yp preceding Election Date, or if such later date is not a Business Day, the immediately preceding Business Day. Final Maturity Date: July 6, 2017, or, if such day is not a Business Day, the immediately preceding Business Day. Election Dates: The 6 th calendar day of each month, from July 6, 2011, through, and including, June 6, 2016, whether or not any such day is a Business Day. 6 th

9 Extentible FABS: Investor decisions S t+1 [0, RE t+1 ] D ιit D ιit+1 t + m t + m + 1 Q t = {Q t, Q FABS t } S t+1 Q t+1 D ιit Withdrawal decision t + m D ιit spinoff maturity date S t+1 Fraction of XFABS RE t+1 Maximum fraction of XFABS converted [t, t + 1] up for election [t, t + 1] Q t XFABS maturing [t, t + m] Q FABS t Predetermined maturing FABS

10 When could there be a self-fulfilling run? If investors withdrawal affects an issuer s expected future liquidity, then there is a possibility of a self-fulfilling run: - If an investor expects other investors to withdraw in future, she becomes concerned about the issuer s future liquidity - Concerns about issuer s future liquidity leads to withdrawal today, adding to the queue of claims on the issuer - The queue affects issuer s actual liquidity, inducing future investors to withdraw, confirming the original expectation

11 Identification problem The partial derivative D it E ts t+1 captures the self-fulfilling effect Withdrawal decision D it and S t+1, and Q are observable Fundamentals and expectations E t S t+1 are not (directly)

12 Econometric specification data reduced form Unit of observation is election t of XFABS i from insurer j Sample from January 1, 2005 to December 31, 2010 Main regression specification is: D ijt = γ 0 + γ 1 S ijt+1 + γ 2 Q ijt + x ijtβ + ɛ ijt D ijt : fraction of XFABS i from insurer j converted on t S ijt+1 : fraction of XFABS converted between t and t + 1 Q ijt : fraction of all XFABS converted prior to t x jt : insurer and time specific and aggregate controls

13 Constructing an IV from XFABS contracts Assumption: E t S ijt+1 S ijt+1 S ijt+1 [0, RE ijt+1 ] D ιijt D ιijt+1 t + m t + m + 1 Q ijt = {Q ijt, Q FABS ijt } S ijt+1 Q ijt+1 D ιijt Withdrawal decision t + m D ιijt spinoff maturity date S ijt+1 Fraction of XFABS RE ijt+1 Maximum fraction of XFABS converted [t, t + 1] up for election [t, t + 1] Q ijt XFABS maturing [t, t + m] Q FABS ijt Predetermined maturing FABS

14 Instrumental variable results Dependent Baseline Weekly FE variable: D ijt 1 st stage 2 nd stage 1 st stage 2 nd stage S ijt *** 1.985** (0.473) (0.657) RE ex12m ijt *** *** (0.0154) (0.0239) Q ijt, Qijt FABS Y Y Y Y Insurer FE Y Y Y Y Weekly FE N N Y Y Observations Robust standard errors in parentheses. p < 1%, p < 5%

15 How much of the run was self-fulfilling? Across specification, 62% to 84% of the $18 billion withdrawn during 2007Q3-2008Q4 can be attributed to the self-fulfilling component

16 Robustness (1/3) Dependent RE ijt+1 at issuance RE ijt variable: D ijt 1 st stage 2 nd stage 1 st stage 2 nd stage S ijt (2.873) (0.923) RE ijt *** (0.0138) RE@I ijt (0.0138) Q ijt+1, Qijt+1 FABS Y Y Y Y Insurer FE Y Y Y Y Observations Robust standard errors in parentheses. p < 1%, p < 5%

17 Robustness (2/3) Dependent Issuer x Month FE Placebo using Q jt+1 variable: D ijt 1 st stage 2 nd stage 1 st stage 2 nd stage S ijt *** (1.310) (0.817) RE ex3m ijt *** *** 0.211** (0.0191) (0.0136) (0.0927) Q ijt+1, Qijt+1 FABS Y Y Y N Insurer FE N N Y Y Insurer-month FE Y Y N N Observations Robust standard errors in parentheses. p < 1%, p < 5%

18 Robustness (3/3) Chari and Jagannathan (1988 JF) showed that there could be runs if uninformed investors act on the actions of informed investors, even though there is no withdrawal externality Regardless of heterogeneity in investors information about fundamentals, a run on XFABS could be self-fulfilling iff there is a withdrawal externality Informed investors expectations are not self-fulfilling unless there is a withdrawal externality Uninformed investors can act on past changes in the queue But do not form self-fulfilling expectations if there is no withdrawal externality

19 Conclusion Evidence of self-fulfilling runs by institutional investors during the crisis The same institutional investors i.e., MMFs were active in ABCP and repo, suggesting that coincidental runs in these markets may also have had a self-fulfilling component However, identifying a self-fulfilling component to the runs in ABCP and repo is not possible FHLB Traditional methods of dealing with runs by bank depositors i.e., liability insurance and regulatory supervision of assets are either infeasible or ineffective to cope with runs by institutional investors

20 Data back Universe of U.S. FABS at a daily frequency: 32 life insurers; 183 SPVs; 2,279 FABS issues For XFABS: CUSIP, issue date, initial & final maturity, election dates Amount liquidated (spinoffs) at election dates Every spinoff is matched to its parent XFABS 65 XFABS; 117 Spinoffs; 1,476 security-election dates Statutory filings, Ratings, CDS, VIX, ABCP, etc.

21 Reduced form results back Dependent No Fixed Kitchen variable: D ijt controls effects sink S ijt *** 0.339*** 0.476** (0.129) (0.158) (0.241) Q ijt Y Y Y Qijt FABS N Y Y Insurer FE N Y Y Quarterly FE N Y Y VIX, ABCP, CDS, EDF, Stk Pr. N N Y Observations Adjusted R Robust standard errors in parentheses. p < 1%, p < 5%

22 Funding Agreement-Backed Securities back

23 FABS as a share of Assets back

24 FHLB Advances to FABS Issuers back

25 Data summary statistics Obs. Median Mean Std. Min Max Dev. Number of XFABS Number of spinoffs XFABS election dates Days b/t election dates XFABS issue amt (USDm) Spinoff issue amt (USDm) Spinoff maturity (days) Dependent var (D ijt ) Endogenous var (S jt+1 ) Instrument (RE ex3m jt+1 ) Maturing FABS (Qjt FABS )

26 Robustness: correlation with RE S jt+1 RE ex3m jt+1 RE jt+1 RE jt RE@I jt+1 3m VIX t S jt+1 1 RE ex3m jt RE jt RE jt RE@I jt m VIX t

27 RE jt+1 is not necessarily a sunspot g A/B (S jt+1 ) A B S jt+1 0 RE jt+1 g A/B (S jt+1 ) is the distribution of beliefs, E A t S jt+1 = 0 Shocks (real or sunspot) switch the distribution from A to B Identification requires E t S jt+1 RE jt+1 during the run

28 Estimated distribution of RE t+1 Kernel density estimate Density RE_ex3m_{jt+1} : Max value of S_{jt+1} kernel = epanechnikov, bandwidth =

29 Scatter plots of S jt+1 with RE jt+1 Allstate Genworth Hartford ING USA S_{jt+1} : Fraction of XFABS liquidated Jackson MassMutual Metropolitan Life Monumental Nationwide New York Life Pacific Life Principal Financial Prudential Security Life of Denver RE_ex3m_{jt+1} : Max value of S_{jt+1} After and before

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31 IV Robustness (bonus) Dependent variable: D ijt RE jt+1 in reduced form S jt *** (0.148) RE jt 0.134*** (0.0416) Q jt+1, Qjt+1 FABS Insurer FE Y Y Observations 921 Robust standard errors in parentheses. p < 1%