Full text of Business Review (Federal Reserve Bank of Philadelphia) : July/August 1989

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ISSN 0007-7011

Federal Reserve Bank of Philadelphia

JULY • AUGUST 1989




JULY/AUGUST 1989

THE COMMUNITY
REINVESTMENT ACT:
INCREASED ATTENTION
AND A NEW POLICY STATEMENT

The BUSINESS REVIEW is published by the
Department of Research six times a year. It is
edited by Patricia Egner. Artwork is designed
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2 FRASER
Digitized for


Paul S. Calem
With the increase in bank mergers and acqui­
sitions has come more attention for the
Community Reinvestment Act. First passed
in 1977, the CR A calls on every bank and thrift
to serve the credit needs of its entire
community— including low- and moderateincome areas— in a manner consistent with
safe and sound banking practices. Over the
years, however, bankers, regulators, and com­
munity groups have developed differing per­
ceptions about the CRA. Community groups
have been protesting some banks' merger
proposals on CRA grounds, and regulators
have been mediating the disputes. To help
dispel the controversy, federal regulators have
issued a CRA policy statement offering guide­
lines for all parties concerned.

HOW DO STOCK RETURNS REACT
TO SPECIAL EVENTS?
Robert Schweitzer
It's no secret that stock markets often react to
new information. Unexpected news about a
firm can change its stock price, simply by
suggesting a different picture for the firm's
profit potential or riskiness. To evaluate the
effects of new information, economists con­
duct "event studies," statistical techniques for
analyzing the pattern of stock prices and re­
turns when a special event occurs. Event
studies have examined how stock returns react
to mergers and acquisitions, to regulatory
decisions, and to changes in a firm's capital
structure. Some of the findings have impor­
tant market and regulatory implications.

FEDERAL RESERVE BANK OF PHILADELPHIA

The Community Reinvestment Act:
Increased Attention
and a New Policy Statement
Paul S. Calem*
Accompanying the recent jump in bank merg­
ers and acquisitions has come increased atten­
tion for the Community Reinvestment Act of
1977. The CRA calls on every bank and thrift to
serve the credit needs of its entire community,

*Paul S. Calem is a Senior Economist and Research
Adviser in the Banking and Financial Markets Section of the
Research Department, Federal Reserve Bank of Philadel­
phia. The author thanks Fred Manning and the rest of the
Philadelphia Fed's Community Affairs Department for
helpful comments.




including low- and moderate-income areas, in
a manner consistent with safe and sound bank­
ing practices. In effect, it requires banks not to
discriminate on the basis of neighborhood
characteristics such as income or racial compo­
sition.
The Act requires federal regulators—the
Federal Reserve, the Comptroller of the Cur­
rency, the Federal Deposit Insurance Corpora­
tion, and the Federal Home Loan Bank Board—to
encourage commercial banks, savings and loans,
and savings banks to meet community credit
3

BUSINESS REVIEW

needs. In addition, the CRA obligates regula­
tors to monitor banks' community reinvest­
ment activities. It also requires regulators,
when ruling on certain applications by a bank
or its holding company, to consider the bank's
record of community lending.
At the same time, the federal regulators are
expected to ensure that banks meet certain
standards for safety and soundness. Accord­
ingly, the regulatory agencies must pursue CRA
goals while permitting banks to make prudent
credit-allocation decisions.
Community groups and lawmakers have
questioned in recent years whether banks have
made sufficient efforts to comply with the CRA.
The community groups, also, have expressed
dissatisfaction with regulatory enforcement of
the CRA. Moreover, they have been filing
numerous protests of banks' proposed merg­
ers and acquisitions, challenging the commu­
nity reinvestment records of the applicants.
Similar concerns have been expressed in Con­
gress, where in 1988 several amendments were
proposed to expand CRA regulation. So far
these amendments have not been made law.
The concerns of lawmakers and community
groups have been fueled by studies that report
wide disparities between low-income or mi­
nority neighborhoods and other areas with
respect to mortgage lending by banks and thrifts.
Community groups view these studies as evi­
dence of discriminatory lending practices.
Unfortunately, such studies are not conclusive
on the issue of discrimination. Those who
disagree with the community groups' interpre­
tation can point to the inability of such studies
to quantify many of the factors that influence
bank lending patterns. As a result, such stud­
ies cannot reconcile differing perceptions about
bank willingness to lend in minority communi­
ties or about their willingness to comply with
the CRA.
Clearly, bankers, regulators, and commu­
nity groups have developed different percep­
tions about the CRA. A new CRA policy
Digitized 4for FRASER


JULY/AUGUST 1989

statement, however, released by the four regu­
latory agencies on March 21, 1989, may help
dispel much of the controversy. The statement
discusses and clarifies how banks can ade­
quately fulfill their CRA responsibilities. Fur­
ther, it strongly encourages financial institu­
tions to keep the public informed about their
community reinvestment activities. It also
encourages community groups to comment on
banks' CRA records on an ongoing basis rather
than wait until the bank files an application.
THE CRA AND COMMUNITY
REDEVELOPMENT
The Community Reinvestment Act was
passed in 1977 and took effect in October 1978.
It was not the first law aimed at increasing the
availability of credit to economically disadvan­
taged areas, or at rectifying alleged discrimina­
tion in lending practices. (See Congress Moves to
End Discrimination and Encourage Community
Redevelopment: 1960-75.) Nevertheless, the CRA
has been the Act most frequently used by
community groups in recent years to gain
support for community redevelopment.
The Goals of the CRA. Congressional pas­
sage of the CRA was motivated primarily as a
response to alleged disinvestment in low-in­
come and minority neighborhoods by financial
institutions.1 CRA proponents argued that fi­
nancial institutions were exporting the funds
obtained from neighborhood depositors and
ignoring community credit needs. They also
argued that banks were discriminating against
low-income and minority neighborhoods by
"redlining" those areas. (A financial institu­
tion is said to be redlining a neighborhood
when it restricts the number or dollar amount
of loans to the area, irrespective of the creditworthiness of individual loan applicants and

T or an analysis of the congressional intent in adopting
the CRA, see Canner [7]. For records of the Senate hearings
on the CRA, see [14] and [15].

FEDERAL RESERVE BANK OF PHILADELPHIA

The Community Reinvestment Act

Paul S. Calem

the value of their collateral.)
CRA proponents also
Congress Moves to End Discrimination
argued that unavailability
and Encourage Community
of credit was a primary
Redevelopment: 1960-75
cause of urban decay. That
allegation has been difficult
Several laws that preceded the Community Reinvestment Act of
to prove, however, because
1977 were designed to end discrimination in housing and credit
of the limitations of the data
markets and spur urban renewal. A series of laws passed in the
available to address the
1950s and 1960s made the mortgage insurance offered by the
issue. But regardless of
Federal Housing Administration more readily available to lowwhether lack of available
income and inner-city borrowers.
credit was a primary cause
The series culminated in 1968 with the passage of the Housing
of the decline of some neigh­
and Urban Development Act. Section 103 of that Act designated
borhoods, it may have been
older, declining urban areas as worthy of special consideration,
a contributing factor. If an
including the waiver of various eligibility requirements for obtain­
individual is denied a home
ing FHA insurance. But the major pieces of anti-discrimination
improvement loan or po­
legislation came during the next 10 years.
The Fair Housing Act, Title VII of the Civil Rights Act of 1968,
tential buyers of his prop­
prohibits discrimination in the sale, rental, financing, or marketing
erty are denied mortgage
of housing. Discrimination based on the buyer's race, religion, or
credit, that individual may
ethnic
backround, on the neighborhood's racial, religious, or ethnic
reduce upkeep of his prop­
composition, or on the age of the property is forbidden. (In 1988,
erty or abandon it altogether.
the provisions of the Fair Housing Act were extended to protect
As a result, the properties
"handicapped" persons and "familial status.")
of his neighbors may lose
The Equal Credit Opportunity Act (ECOA), enacted in 1974,
value, and some of them
prohibits discrimination against credit applicants on the basis of
may decide to reduce up­
race, color, religion, national origin, marital status, or age. The
keep or abandon their prop­
ECOA also prohibits discrimination against persons deriving in­
erties as well.
come from public assistance, or against persons who have exer­
cised any right under the Consumer Protection Act.
The CRA can be viewed
The Home Mortgage Disclosure Act (HMDA), enacted in 1975,
as an effort to check this
requires
depository institutions to disclose publicly, by census
sort of acceleration of neigh­
tract,
the
number and dollar amount of their originations and
borhood decay and aban­
purchases of home mortgages and home improvement loans. Sup­
donment. The Act reminds
porters of HMDA believed that public disclosure would deter in­
banks that, having been
stitutions from "redlining" inner-city neighborhoods and would
granted public charters and
facilitate enforcement of the Fair Housing Act.
special privileges such as
deposit insurance, they have
an obligation to help meet the credit needs of responsibilities under the CRA may be met in a
their entire community. Moreover, by encour­ variety of ways, including lending for busi­
aging every bank in this way, the CRA helps ness, agriculture, education, and home pur­
remove a significant obstacle to stabilizing a chase and improvement, or to finance state and
neighborhood— each bank's fear of being the local governments.
Regulations for Financial Institutions. The
only one lending in blighted neighborhoods.
The CRA applies to all commercial banks, all four regulatory agencies are directed to assess
savings banks, and all savings and loans. Their periodically each financial institution's efforts



5

BUSINESS REVIEW

to meet community credit needs in a manner
consistent with safe and sound operation. When
considering a bank's application to open a
branch, to acquire another bank, or to merge
with another bank, a regulatory agency must
consider each institution's record of commu­
nity lending.
To implement the CRA, the Federal Reserve
System issued R egulation BB in 1978, and the
other federal regulatory agencies adopted regu­
lations virtually identical to it. These regula­
tions require an institution to issue a CRA
statement, to post a public notice about the
CRA, and to establish a file for comments from
the public on the institution's CRA perform­
ance. The CRA statement must contain a map
showing the local community that the institu­
tion serves, and it must list the types of loans
the institution is willing to make. Any written
comments received from the public over the
past two years must be kept on file and be
made available for public review. The CRA
notice must explain how to obtain copies of the
institution's CRA statement, and make known
where and to whom comments on the institu­
tion's CRA record may be sent.
The regulations also list 12 criteria to be used
in assessing an institution's record of commu­
nity service. These include the institution's
efforts to assess its community's needs, its
efforts to market credit services to the entire
community, its efforts to ensure that no seg­
ment of its community is improperly excluded,
its record of opening and closing branches, its
participation in local community development
programs and government-supported lending
programs, and the geographic distribution of
its residential and small-business loans.
As required by the CRA, the four regulatory
agencies periodically review the community
lending records of the institutions they super­
vise, including the comments contained in each
institution's public file. These reviews are
carried out in conjunction with regularly sched­
uled supervisory exams. The CRA examiners
Digitized for
6 FRASER


JULY/AUGUST 1989

prepare a written report to the institution's
directors, suggesting ways in which the insti­
tution can improve its record. In addition, the
examiners assign a confidential CRA rating to
the institution. A rating of 1 (strong) or 2
(satisfactory) is a passing grade, indicating
compliance with CRA. Institutions rated 3
(less than satisfactory), 4 (unsatisfactory), or 5
(substantially inadequate) are expected to take
steps to improve their performance.
Also as required by the Act, the regulatory
agencies, when deciding whether to approve
an institution's application (an application, say,
to acquire another bank), consider the institu­
tion's community reinvestment record, along
with competitive, financial, and managerial
factors. Members of the public may formally
protest an application on the basis of the appli­
cant's or acquiree's record, provided the protestants submit their written comments within
a specified period.
Agencies Try to Smooth the Way. Often, on
receiving a protest, a regulatory agency will
arrange private meetings between the appli­
cant and protestant at which the parties try to
iron out their differences. In many cases, these
meetings lead to a negotiated agreement, which
generally involves a commitment by the appli­
cant to take specific measures to improve its
CRA record. For instance, the applicant might
agree to form a Community Advisory Board.2
Or the applicant may pledge to increase its
participation in government-insured credit
programs. Sometimes, applicants have prom­
ised to extend a minimum dollar volume of
loans to targeted neighborhoods over a speci­
fied period. But regardless of whether such an
agreement is reached, the regulatory agency
must decide whether the applicant's CRA rec­

2A Community Advisory Board consists of representa­
tives of the local community, who periodically meet with
bank management and provide advice on lending opportu­
nities.

FEDERAL RESERVE BANK OF PHILADELPHIA

The Community Reinvestment Act

Paul S. Calem

ord is adequate for approval of the applica­
tion.3
The regulatory agencies have set certain
limits on the influence they are prepared to
exert over the community reinvestment activi­
ties of financial institutions. In the first place,
they will not pressure a lender into making
credit decisions that are inappropriate from
the viewpoint of safety and soundness. In ad­
dition, the agencies have sought to avoid credit
allocation, by not setting reinvestment targets
as a measure of lender performance. Deposi­
tory institutions are not asked to commit to
specific targets in connection with compliance
exams or protested applications. Furthermore,
financial commitments that institutions make
to community groups in connection with pro­
test agreements are not generally endorsed by
the regulators.
Both the Federal Reserve and Federal Home
Loan Bank Board have sought to facilitate bank
compliance with the CRA by hiring commu­
nity reinvestment specialists who disseminate
advice and information. The FHLBB has as­
signed a Community Investment Officer to
each of its 12 district banks; similarly, the Fed­
eral Reserve System established Community
Affairs units at its 12 Reserve Banks. These
specialists advise banks, thrifts, and commu­
nity groups on the CRA and on ways to sup­
port community development. They also act
as go-betweens, bringing the concerns of com­
munity groups to the attention of lenders.4
Increased Participation by Banks. Banks
and thrifts generally have expressed support
for the CRA in principle. Many banks believe
that community reinvestment was always an
integral part of their role as providers of de­

posit and credit services, and that they were
responsive to community needs long before
the CRA was adopted. In fact, some banks'
special programs aimed at community rein­
vestment predate the CRA.5
As envisioned by the original proponents of
the CRA, bank participation in neighborhood
redevelopment projects has increased over the
past 11 years. This participation has taken
many forms. (See Public/Private Partnerships:
Banks Reinvesting in Their Communities, p. 8.)
One important form has been CDCs, or com­
munity development corporations. Chartered
to provide loans and other support for commu­
nity development projects, CDCs often focus
on special community needs such as low-in­
come housing or small-business revitalization.
CDC subsidiaries of banking organizations are
granted special powers usually not available to
other bank subsidiaries—for instance, the au­
thority to take equity positions or own real
estate.
The CRA also has helped sensitize banks to
the needs of their communities. This increased
awareness has taken many forms, ranging from
foreign-language signs in bank lobbies to spe­
cial marketing programs aimed at low-income
areas.

3For a more complete description of the CRA regulations
and protest procedures, see [16].
4Bankers may also benefit from the ideas and advice on
CRA compliance offered by their own trade associations,
such as those in a recent American Banker feature section [18].

5For instance, the "Philadelphia Mortgage Plan," a
cooperative effort by Philadelphia-area banks to increase
the availability of mortgages in low-income neighbor­
hoods, was instituted in 1975. The Plan currently is sup­
ported by 11 lending institutions.




RECENT DEVELOPMENTS
Loosened constraints on interstate banking
have swelled the number of bank applications
for mergers or acquisitions. Community rein­
vestment advocates have been scrutinizing these
applications, and the number of protests filed
with regulators has increased dramatically. The
Federal Reserve saw an average of about five
protests per year between 1980 and 1984; the

7

BUSINESS REVIEW

JULY/AUGUST 1989

Public/Private Partnerships:
Banks Reinvesting in Their Communities
Prompted in part by the CRA, many banks have been aiding community redevelopment by sup­
porting locally based public /private partnerships that provide loans, grants, and technical assistance
to private development initiatives. Some banks participate directly, collaborating with representa­
tives of government, business, foundations, and community organizations. Others channel their sup­
port through institutions such as the Local Initiatives Support Corporation (LISC) and the Enterprise
Foundation.
The New York City-based LISC, founded in 1980, raises corporate and foundation funds for the
support of community development in over 20 U.S. cities. The Maryland-based Enterprise Founda­
tion, launched in 1982, is a charitable foundation that organizes and supports local nonprofit groups
engaged in housing rehabilitation. The Foundation provides small seed-money grants and lowinterest loans, offers advice on design and construction methods to cut costs, and helps neighborhood
groups obtain additional financing and business support.
Many of the public/private partnerships with which banks are involved are members of the
NeighborWorks Network, a national network whose principal members are the local, nonprofit
Neighborhood Housing Services (NHS) partnerships. NHS partners include neighborhood resi­
dents, local businesses, financial institutions, insurance companies, and charitable foundations. The
partners support neighborhood rehabilitation by contributing time, expertise, loans, insurance pro­
tection, and other services on a voluntary basis. Moreover, each NHS makes available a revolving
loan fund for residents whose low income or poor credit history make them ineligible for bank loans.
The NeighborWorks Network receives additional support from the Neighborhood Reinvestment
Corporation, a congressionally chartered, public nonprofit corporation. The Corporation receives a
federal appropriation and provides grants, training, and technical assistance to the NeighborWorks
system. The Corporation's board of directors includes representatives of the financial regulatory
agencies.

number jumped to 19 in 1985 and 20 in 1986,
rose to 35 in 1987, and fell back slightly to 30 in
1988. At the Office of the Comptroller of the
Currency, the number of protests rose from
zero in 1984 to three in 1985, to eight in 1986, to
nine in 1987, then back to zero in 1988.6*
The Involvement of Community Groups.
The increase in protest activity since 1986 can
be attributed not just to the new interstate
merger activity but also to heightened activism

6Almost no interstate bank mergers in 1988 came under
the jurisdiction of the OCC. The FDIC and FHLBB rarely
have received protests.

Digitized for
8 FRASER


on the part of local community advocates and
the organizations that assist them. The latter
include the Center for Community Change, the
National Training and Information Center, and
the Association of Community Organizations
for Reform Now. CFCC and NTIC provide
legal and technical advice to local groups con­
cerning the CRA and neighborhood revitaliza­
tion. ACORN is an association of local commu­
nity groups with chapters nationwide.
Cutbacks in federal aid for housing and
community development made community
groups eager to obtain loans and assistance
from banks. In addition, regulators cut back on
resources allocated to CRA examinations and
consumer protection, in order to meet the in­
FEDERAL RESERVE BANK OF PHILADELPHIA

The Community Reinvestment Act

creasing costs of other supervisory functions
(costs that were required because more banks
were experiencing financial difficulties and
because increased diversification by banks was
making their operations more complex). Per­
ceiving that CRA enforcement had eased,
community groups felt compelled to take up
the slack.7 Another contributing factor was the
fear that acquisitions of local banks by out-ofstate banks would siphon funds from local
communities.
Community groups contend that protesting
bank applications is an unwelcome task that
would be unnecessary if banks were fulfilling
their CRA responsibilities. They contend that
the regulatory agencies devote insufficient
resources to supervising banks' compliance
with the CRA, and they would like the
agencies to apply stricter standards in assess­
ing bank performance. They especially would
like to see more lending in low-income and mi­
nority neighborhoods by banks receiving pass­
ing grades from regulators. Alternatively, they
would like to see more favorable terms (such as
smaller minimum down-payments) on such
loans.8
Allegations of Discrimination. In arguing
that compliance has been inadequate, commu­
nity groups point to recent studies suggesting
that the redlining of low-income and minority
neighborhoods remains a common practice. A
number of such studies have been widely
publicized. A series of articles in the Atlanta

7According to Fishbein [10], who relied on data supplied
by the public interest organization Bankwatch, total exam­
iner hours spent per year on CRA compliance and consumer
protection fell about 75 percent at the FDIC, OCC, and
FHLBB between 1981 and 1984. At the Federal Reserve,
total examiner hours per year declined about 25 percent. In
1986, the Federal Reserve switched from an 18-month to a
24-month CRA exam cycle for banks rated satisfactory or
higher.
8For an elaboration on community group grievances, see
Fishbein [10] and Brown, Brown, and Fishbein [5].




Paul S. Calem

Journal/Constitution (May 1-4, 1988) reported
wide differences between predominantly white
and predominantly minority neighborhoods
in Atlanta with respect to the number of homepurchase loans extended by depository institu­
tions. These differences persisted even after
controlling for differences in median family
income and the number of single-family homes.
Similar results were reported regarding lend­
ing patterns in Detroit, Wilmington, and Bos­
ton, in separate articles in the Detroit Free Press
(July 24-27,1988), the Wilmington News Journal
(November 20, 1988), and the Boston Globe
(January 11, 1989).9 These studies, because
they were based on data reported by deposi­
tory institutions in compliance with the Home
Mortgage Disclosure Act, did not include lend­
ing by mortgage bankers.10*
These reports and associated allegations of
mortgage redlining have attracted the atten­
tion of lawmakers. Both the House and the
Senate tacked community reinvestment provi­
sions on to bills to repeal the Glass-Steagall Act
in 1988. The Senate version of the bill required
that a bank's community reinvestment record
be evaluated in connection with applications to
engage in nonbanking activities, such as dis­
count brokerage. The House version included
several CRA amendments. One called on the
federal banking agencies to develop guidelines
for rating a bank's community reinvestment
performance and to base such ratings on com­
parative performance. Another called for
approval of applications to be contingent on

9In addition, the Atlanta Journal/Constitution published
an analysis of rejection rates on loan applications at thrift
institutions, using data collected by the FHLBB. The report
found rejection rates to be substantially higher among
blacks and other minorities, even after controlling for in­
come.
10The HMDA data only include figures on bank lending
by census tract. In fact, even mortgage subsidiaries of bank
holding companies were not included in HMDA data prior
to this year.

9

BUSINESS REVIEW

the applicant's CRA rating. While a final bill to
repeal Glass-Steagall did not pass Congress
last year, the issue of CRA reform may reap­
pear.
THE REDLINING CONTROVERSY
Although recent allegations of redlining have
attracted a great deal of publicity and atten­
tion, the studies underlying these allegations
are fraught with shortcomings. Studies of the
geographic distribution of mortgage loans
generally cannot measure accurately a neigh­
borhood's demand for loans. This is a critical
omission, since it is difficult to allege that a
bank is refusing to supply credit if there is no
demand. In addition, some of the valid eco­
nomic factors that might explain why loans are
not supplied may correlate with a neighbor­
hood's racial or income characteristics. Conse­
quently, allegations of redlining that are based
on such studies can be challenged.11
Measuring Mortgage Demand. A neigh­
borhood's demand for mortgages is influenced
by numerous variables (see Factors Affecting
Mortgage Demand). Some of the demand vari­
ables may be correlated with per capita income
or percentage of minority population and thus
may incorrectly suggest the presence of redlin­
ing. For instance, fewer people may be moving
into predominantly black, inner-city neighbor­
hoods because of a decline in public services or
the closing of factories in those areas. Or
housing turnover may be proceeding more
rapidly in middle-income areas than in lowincome areas because of locational conven­
ience and better condition of the housing stock.
Or more homes may be sold in neighborhoods
with young, well-educated residents, who tend
to move more frequently than others do. As a
result, minority or low-income neighborhoods

n See Benston [4] and Canner [8] for reviews of the
redlining literature.

Digitized for
10 FRASER


JULY/AUGUST 1989

may appear to be redlined.
Most existing studies assume that total neigh­
borhood demand for mortgages varies in pro­
portion to the number of residences in the area.
But that is a crude assumption, since the de­
mand for mortgages depends on many other
variables. A few studies, including those by
Canner [6] and Avery and Buynak [2], assume
that mortgage demand varies in proportion to
the total number of real estate transfers in a
neighborhood. However, some transfers do
not require mortgages, such as those resulting
from death, divorce, or cash purchases. On the
other hand, some mortgages are not connected
to transfers, such as those issued for refinancing.
A major drawback to using transfers is that
such data are costly to obtain.12
Other Problems Confronting Researchers.
Any analysis of mortgage lending patterns is
further complicated by the need to consider
default risks and costs. To protect the interests
of their stockholders and the FDIC, banks must
avoid making unsound loans—loans that carry
a high risk of default and loans that would
involve substantial losses in the event of de­
fault.
Banks must evaluate borrower
creditworthiness—the likelihood that a bor­
rower will repay a loan according to schedule.
In addition, banks must assess the expected
future value of a property being mortgaged,
which would serve as collateral in the event of
default. If a borrower is not considered credit­
worthy, or if a property value appears to be
unstable, then a bank is likely to deny the
mortgage or require a higher down-payment.

12Data on mortgage applications by census tract, which
might serve as a proxy for mortgage demand, are also
difficult to obtain. Moreover, the usefulness of such data
would be reduced by the pre-screening of mortgage
applicants—because many potential applicants might be
dissuaded from applying at an initial, interview stage. The
impact of pre-screening could vary across neighborhoods,
making applications data a poor proxy for mortgage de­
mand.

FEDERAL RESERVE BANK OF PHILADELPHIA

The Community Reinvestment Act

Paul S. Calem

Factors Affecting Mortgage Demand
The demand for mortgages depends both on the potential number of property transactions and
on the propensity of potential buyers to seek mortgages and not alternative sources of financing. In
the first place, the potential number of property transactions depends upon the number of owneroccupied units in the neighborhood (there will be little demand for mortgages in a neighborhood
composed primarily of rental apartments). But the potential number of property transactions
depends on other factors as well, such as the age and educational levels of a neighborhood's popu­
lation. For instance, a neighborhood in which many people are near retirement age is likely to have
a relatively large number of homes for sale, as many people prefer to move into smaller homes or
apartments upon retirement.
The potential number of property transactions in an area also is affected by circumstances that
make the area less attractive to current residents and more attractive to new residents or investors.
Thus, neighborhood housing turnover might be affected by city-wide demographic or economic
conditions, or by changes in property tax rates or in the distribution of city services.
What impact such circumstances might have upon a neighborhood would depend upon neigh­
borhood characteristics. Relevant variables could include the area's accessibility to business and
manufacturing districts; the quality of neighborhood schools and shopping; amenities such as parks,
trees, and clean streets; disamenities such as traffic congestion, crime, or noise; the median income
of the residents; and the age and condition of the housing stock. For instance, a clean, quiet neigh­
borhood primarily populated by manufacturing workers might experience a high turnover rate as
the local economy becomes more services-oriented. Or housing turnover may be relatively rapid in
some central-city areas if there is an increase in the proportion of single or childless young profes­
sionals in the city's work force, as such individuals tend to seek housing in downtown areas.
The frequency with which potential buyers seek mortgage financing also can vary across neigh­
borhoods. Some buyers might instead turn to cash or personal loans to finance the transaction. For
example, in the metropolitan area of Louisville, Kentucky, individuals used cash or personal loans
to finance some 36 percent of properties in the city compared to 14 percent in the suburbs, according
to Koebel [12].

But legitimate criteria for determining creditworthiness might be correlated with neighbor­
hood racial or income composition, and future
property values also might be correlated with
those neighborhood characteristics. As a re­
sult, legitimate credit decisions may give the
appearance of redlining or discrimination. (See
A Bank's Credit Decision: Evaluating Potential
Losses, p. 12.)
For instance, borrowers may be considered
poor credit risks because they are unable to
make minimum down-payments, or because
they would have almost no savings or liquid
assets left over after making minimum down­



payments.13 Or, for another instance, housing
values may be declining in some low-income

13Down-payment requirements can be as low as 5 per­
cent for mortgages that are insured by private mortgage
insurance companies or by a government program such as
FHA or VA. But some borrowers may not meet even such
minimal down-payment requirements. Or banks might
perceive mortgage insurance itself as risky because, in the
last few years, the private mortgage insurance industry has
been beset by some financial problems. Moreover, some
borrowers may be unable to afford the insurance premium,
while others may be unable to obtain mortgage insurance
because of risk factors. Also, insurers themselves have, at
times, been accused of redlining; see, for instance, [17].

11

JULY/AUGUST 1989

BUSINESS REVIEW

A Bank's Credit Decision:
Evaluating Potential Losses
A borrower's inability or unwillingness to repay a mortgage imposes costs on the lender. These
costs include the legal expenses related to taking possession of the property, the expenses related to
maintaining the property until it is sold, and the amount by which the unpaid loan balance and
interest exceed the property value.
Thus, before granting a loan, a bank must evaluate the potential for default by the borrower. Loan
applicants are evaluated based on such factors as their income and credit history and the adequacy
of the collateral. Loans viewed as risky may not be offered. When they are offered, the bank, in order
to lower its risk exposure, may require a higher down-payment that would reduce the value of the
loan relative to the value of the property. Alternatively, such loans may be offered only to those
borrowers who obtain mortgage insurance.
Borrower characteristics can influence a bank's perception of the borrower's probability of
default. Defaults often occur when a borrower is unable to meet monthly mortgage obligations
because of a decline or disruption in income or an increase in nonmortgage expenses. Hence, lowincome borrowers may be viewed as more risky, since they generally work in more cyclical
industries, tend to be younger and less experienced, and therefore are more prone to disruptions in
income. Similarly, borrowers with little savings beyond what they would use for their mortgage
down-payment represent greater default risks, as they have no liquidity available for emergencies.
The risk of default also is likely to be higher for a borrower who has nonmortgage debts or liabilities
or a poor credit history.
Since neighborhood and property characteristics affect the value of the collateral, they influence
both the risk of default and the costs associated with foreclosure. A borrower who has experienced
a disruption in income is more likely to default if the sale of the property would not provide sufficient
cash to repay the mortgage.
Sometimes, borrowers default even though they are capable of meeting their monthly mortgage
obligations. Such voluntary defaults occur when the value of a property falls sufficiently below the
outstanding mortgage balance and the owner has little equity in the property. In this case, an owner
might decide it is no longer worthwhile to continue paying the bills and walk away from his
obligation.
Homes that are poorly constructed or poorly maintained, homes located near abandoned,
dilapidated properties, and homes in areas with declining city services or amenities (or in areas with
increasing crime or disamenities) may be more vulnerable to a decline in value. Hence, such
properties may represent a greater risk and cost of default.
Several empirical studies have looked at the relationship between foreclosure rates, as a proxy for
default risk, and borrower/ neighborhood /property characteristics. Neighborhood variables such
as the rate of decline of housing prices, per capita income, the unemployment rate, and condition of
the housing stock generally are found to be correlated with foreclosure rates. For instance, a carefully
done study by Barth, Cordes, and Yezer [3] found foreclosure rates to be higher in cities with lower
per capita income, in blighted neighborhoods, on properties in poor condition, and on houses
constructed of wood siding.
In addition, lower appraised property value was associated with a higher loan-to-value ratio, and
lower income per person in a household was associated with a higher monthly-payment-to-income
ratio. These factors, in turn, were associated with higher foreclosure rates.

Digitized 12
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FEDERAL RESERVE BANK OF PHILADELPHIA

The Community Reinvestment Act

neighborhoods for reasons unrelated to credit
availability, such as a company moving out of
the area. Banks may then make fewer loans in
those areas because, as time goes on, fewer
properties will constitute adequate collateral.
Studies of neighborhood lending patterns
cannot adequately control for variations in de­
fault risk and cost across neighborhoods. Ex­
isting methodologies do not allow the risk and
cost effects of some variables, such as median
income, to be distinguished from redlining.
And some neighborhood variables that affect
default risk, such as average household assets,
are not included because of lack of data. Bor­
rowers' nonmortgage liabilities and overall credit
records also are not available.
A further problem is that of lender speciali­
zation. Many commercial banks concentrate
on nonmortgage lending and thus are adept
only at making conventional mortgages. But
mortgage finance companies (known as mort­
gage bankers) specialize in mortgage lending,
and their personnel develop expertise in all
aspects of that business. As a result, mortgage
bankers may be more flexible than banks in
setting mortgage terms, or more efficient at
processing applications for insured mortgages.
Therefore, individuals in low-income or mi­
nority neighborhoods may prefer to rely on
mortgage bankers for residential loans. In that
case, banks would face fewer applicants for
mortgages in those neighborhoods—and so
would necessarily grant fewer mortgages. One
could not infer, then, that banks are redlining
those areas.14
Some Interesting Findings. While studies of
mortgage lending patterns do not yield conclu­
sive evidence of redlining, they do provide
some interesting insights. These studies con­

14Alternatively, minority home-buyers might be steered
toward mortgage companies by real estate agents, or they
may be reluctant to deal with banks because of a past history
of discrimination by banks.




Paul S. Calem

sistently find that the number of mortgages in
an area increases with median family income
or income per capita. They typically find that
the number of mortgages is inversely related to
one or more of the following variables: per­
centage of households below the poverty level;
age of the housing stock; neighborhood blight
as indicated by the number of vacant or de­
serted buildings; and percentage of minority
population. Also, the literature confirms that
most insured mortgages are provided by mort­
gage companies and that mortgage companies
have a larger share of total mortgages in poor
and minority neighborhoods.15*
Although the allegations of discriminatory
lending by banks can be challenged, the issue
of whether banks are doing enough to comply
with the CRA covers more than just the ques­
tion of redlining. The question of discrimina­
tion aside, the problem remains whether banks
are doing enough to help meet credit needs in
low -incom e and m inority neighborhoods.
Community groups have been expressing dis­
appointment with the overall compliance ef­
forts of banks. On the other hand, some bank­
ers feel that community groups have unrealis­
tic expectations and are too quick to protest
bank applications on CRA grounds.
Against this background of controversy, the
regulatory agencies recently released a new
CRA policy statement. The statement attempts
to clarify what the agencies expect from finan­
cial institutions in the way of complying with
CRA, and what they expect from community
groups in the way of communicating their
concerns to banks.
THE NEW POLICY STATEMENT
The new statement on CRA policy released
by the four regulatory agencies is expected to

15See, for instance, Ahlbrandt [1], Dingemans [9], and
Hutchinson, Ostas and Reed [11].

13

BUSINESS REVIEW

help dispel the controversy over the CRA.
First, the statement provides financial institu­
tions with guidelines for an effective compli­
ance program. The guidelines call for an ongo­
ing effort by financial institutions to ascertain
community needs, through outreach to local
government, business, and community organi­
zations. In addition, the guidelines call for a
continuing commitment by banks to develop,
market, and advertise products and services
that are responsive to community needs. Other
important elements include management in­
volvement and oversight and an employee
training program. The policy statement im­
plies that the regulatory agencies, in evaluating
compliance, will focus on an institution's at­
tempts to comply with these guidelines.16
Further, the policy statement suggests a
number of specific steps an institution can take
toward assuring compliance. These include
making special efforts to meet identified credit
needs within the community (for instance,
participating in government-insured lending
programs); providing services that would benefit
low- and moderate-income persons (such as
low-cost checking accounts); advertising the
availability of such services; directly market­
ing credit services to targeted groups, such as
small-business owners and real estate agents in
low- and moderate-income neighborhoods;
establishing a community development corpo­
ration; and underwriting or investing in state
and municipal bonds.
In addition to clarifying how banks can meet
their CRA responsibilities, the statement strongly
encourages steps toward improving commu­
nication among banks, regulators, and com­
munity groups. Each institution is advised to
include in its standard CRA statement up­
dated information on its community reinvest­
ment activities. Also, each institution is ad­
vised to carefully document and record the

16See the Joint Statement [19].


14


JULY/AUGUST 1989

steps it takes to fulfill its CRA responsibilities.
At the same time, the policy statement encour­
ages community groups to file comments on an
institution's compliance record at the earliest
possible time rather than during the applica­
tions process.
The statement also spells out regulatory
policies regarding examinations and reviews
of applications. It states: "When considering
public comments received during the applica­
tions process, the agencies will take into ac­
count whether the institution has provided to
the public an expanded CRA statement, and
whether the commenter has submitted com­
ments to the institution outside of the applica­
tions process." The policy statement also
emphasizes that, in conducting compliance
examinations, the regulatory agencies will care­
fully consider comments from the public re­
garding an institution's performance. In addi­
tion, the statement suggests that the agencies
will be more inclined to deny applications from
banks whose compliance record is found to be
inadequate than to rely on commitments to
future action.17
While the new CRA policy statement stresses
some new approaches to CRA enforcement,
some things won't be changing. Safety and
soundness considerations still apply to all lend­
ing decisions. And the regulators still want to
avoid credit allocation.
The new CRA statement is expected to help
banks implement more effective compliance
programs. It will provide community groups
with a better idea of what they can expect from
banks and regulators. It will likely be a catalyst
for improved communication. And it could
help alleviate community groups' doubts about
bank compliance with the CRA.

17The Federal Reserve also may have signaled a more
aggressive stance when it issued its first denial ever on CRA
grounds, a few weeks before the new policy statement was
released. The denial involved an application by Continen­
tal Illinois to expand into Arizona.

FEDERAL RESERVE BANK OF PHILADELPHIA

The Community Reinvestment Act

Paul S. Calem

REFERENCES AND SUGGESTED READINGS
[1] Ahlbrandt, Roger S., Jr. "Exploratory Research on the Redlining Phenomenon," American Real
Estate and Urban Economics Association Journal 5 (Winter 1977) pp. 473-81.
[2] Avery, Robert B., and Thomas M. Buynak. "Mortgage Redlining: Some New Evidence," Federal
Reserve Bank of Cleveland Economic Review (Summer 1981) pp. 18-32.
[3] Barth, James R., Joseph J. Cordes, and Anthony M. J. Yezer. "Financial Institution Regulations,
Redlining, and Mortgage Markets," in The Regulation of Financial Institutions, Conference Series
21, Federal Reserve Bank of Boston (1979) pp. 101-43.
[4] Benston, George. "Mortgage Redlining Research: A Review and Critical Analysis," in The
Regulation of Financial Institutions, Conference Series 21, Federal Reserve Bank of Boston (1979)
pp. 144-95.
[5] Brown, Mildred, Jonathan Brown, and Allen J. Fishbein. Testimony before the Committee on
Banking, Housing, and Urban Affairs of the U.S. Senate, September 9,1988.
[6] Canner, Glenn B. "Redlining and Mortgage Lending Patterns," in J. Vernon Henderson, ed.,
Research in Urban Economics: A Research Annual. Greenwich, Connecticut: JAI Press (1981) pp.
67-101.
[7] Canner, Glenn B. The Community Reinvestment Act and Credit Allocation. Washington: Board
of Governors of the Federal Reserve System, Staff Studies 117 (1982).
[8] Canner, Glenn B. Redlining: Research and Federal Legislative Response. Washington: Board of
Governors of the Federal Reserve System, Staff Studies 121 (1982).
[9] Dingemans, Dennis. "Redlining and Mortgage Lending in Sacramento," Annals of the Association
of American Geographers 69 (June 1979) pp. 225-39.
[10] Fishbein, Allen J. Testimony before the Committee on Banking, Housing, and Urban Affairs of
the U.S. Senate, March 22,1988.
[11] Hutchinson, Peter M., James R. Ostas, and J. David Reed. "A Survey and Comparison of
Redlining Influences in Urban Mortgage Lending Markets," American Real Estate and Urban
Economics Association Journal 5 (Winter 1977) pp. 463-72.
[12] Koebel, Theodore. Housing in Louisville: The Problem of Disinvestment. Louisville, Kentucky:
Urban Studies Center, University of Louisville (July 1978).
[13] Seger, Martha R. Statement before the Committee on Banking, Housing, and Urban Affairs of
the U.S. Senate, March 23,1988.




15

BUSINESS REVIEW

JULY/AUGUST 1989

[14] Community Credit Needs. Hearings before the Committee on Banking, Housing, and Urban
Affairs of the U.S. Senate, 95 Cong. 1 Sess., U.S. Government Printing Office (1977).
[15] Housing and Community Development Act of 1977. Senate Report 95-175, 95 Cong. 1 Sess., U.S.
Government Printing Office (1977).
[16] A Citizens Guide to CRA. Washington: The Federal Financial Institutions Examination Council
(1985).
[17] "Inner-City Neighborhoods and the MI Industry: A Report on Causes of Industry Losses." Chicago:
National Training and Information Center (March 1988).
[18] "Community Reinvestment— Special Report," American Banker (March 28,1989) pp. 13-30.
[19] "Statement of the Federal Financial Supervisory Agencies Regarding the Community Reinvest­
ment Act," March 21, 1989.

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FEDERAL RESERVE BANK OF PHILADELPHIA

How Do Stock Returns React
to Special Events?
Robert Schweitzer*
Investors expect stock prices to react to some
special events as a matter of course. They're
rarely as certain, however, about the timing
and magnitude of that reaction, and sometimes
they aren't even sure of the direction.
This much, however, is known: unexpected
events can change the stock prices of a firm by
changing the profit potential or riskiness of
that firm. And if the financial markets pick up
information about an impending event, that
event can change stock prices days or weeks

^Robert Schweitzer is an Associate Professor of Finance
at the University of Delaware. He wrote this article while he
was a Visiting Scholar in the Research Department of the
Federal Reserve Bank of Philadelphia.




before it actually occurs—and continue to in­
fluence stock prices for some time thereafter.
That stock markets quickly digest all new
public information about firms and transmit it
rapidly into changes in stock prices underlies a
methodology now being used frequently in
financial analysis. To provide some insights
into how the equities market reacts to new
information, financial economists have con­
ducted "event studies," statistical techniques
for analyzing the pattern of stock prices and
returns when a special event occurs.
Event studies offer insight into such issues
as the extent to which shareholders of acquired
firms gain abnormal returns during mergers,
and the extent to which bad news affects banks'
17

BUSINESS REVIEW

stock returns. Some of these studies have
implications for how forthcoming regulatory
and market changes will affect banking firms.
The methodology of event studies may
appear complicated, but the basic idea is quite
simple. Many such studies have been con­
ducted to analyze specific events in both the
corporate finance and banking fields. A review
of some of these studies shows how much
stock returns can change in response to new
information about a group of firms or a par­
ticular industry.
THE METHODOLOGY
OF EVENT STUDIES
Event studies examine the stock returns for
some specific firms (or for an industry) before
and after the announcement of a special event—a
merger, say. The returns for a certain holding
period are calculated by adding the stock's
dividend for the period to the change in the
stock's price (a capital gain or loss) and divid­
ing by the initial stock price. The capital gain
(or loss) is included, since the investor could
realize this gain (or loss) by selling the stock.
Changes in the stock's price, then, have a major
effect on the stock's returns.
News of a significant event could alter the
pattern of stock returns for a firm (or industry).
Suppose an event is taken as good news—that
is, investors believe the event portends a bright
future for the firm. The firm's stock price will
increase as a result. This price increase repre­
sents a capital gain, which raises the return on
the firm's stock.
But the stock returns might have changed
for other reasons. The stock's price, and hence
the returns, could have changed just from the
overall movement in the stock market itself.
The magnitude of this change will depend on
the degree to which the firm's stock moves
with the overall market. Stock analysts report
that some stocks move almost in a one-to-one
relationship with the stock market, while oth­
ers do not move with the market at all. The
Digitized 18
for FRASER


JULY/AUGUST 1989

difficult part of event studies is to make adjust­
ments for overall movements of the stock market,
as well as for other events unrelated to the
specific announcement under study. To do so,
event studies follow four basic steps.
Identification of the Event. The first step is
to identify the event and the date on which it
occurred. Usually, the event of interest is a
single, one-time occurrence— a merger of two
firms, for example. Other event studies inves­
tigate the impact on a group of firms (or on a
specific industry) of a frequently occurring
event, such as earnings announcements.
Compared to studies of one-time events, this
second type usually provides more reliable
results because it covers a group of companies
over different periods. If the results are the
same for different firms at different points in
time, we can be more confident of the event's
impact.
Estimation of Abnormal Returns. The eventstudy methodology calls for examining the
returns on a firm's stock around the date se­
lected and separating out the portion of the
total returns that is a reaction to the event. Part
of the returns on a firm's stock reflects ups or
downs in the overall stock market. The re­
mainder reflects the unexpected event.
To separate the general movement of stock
returns from an individual stock's return, econo­
mists calculate what are called "abnormal re­
turns." Abnormal returns, also called "excess
returns," represent the firm's return after sub­
tracting out returns attributable to overall
movements of the stock market.
Statistical models of the firm's stock returns
are used to determine "normal returns"—an
estimate of the firm's returns in the absence of
the event. The estimated normal returns are
subtracted from the actual returns, with the
difference being the abnormal returns. (For
details on the approaches to estimating normal
returns, see Estimating Returns, p. 25.) The pat­
tern of the abnormal returns should show the
event's impact, if there is one.
FEDERAL RESERVE BANK OF PHILADELPHIA

How Do Stock Returns React to Special Events?

Grouping of the Abnormal Returns. Once
obtained, the abnormal returns for the firms
under study are grouped for analysis. The
usual approach is to calculate the cross-section
average and cumulative abnormal returns for
the firms. The cross-section average abnormal
returns are calculated by summing the abnor­
mal returns and dividing by the number of
firms in the study; the averages take into ac­
count the possibility that the event may have
different impacts on the firms in the sample.
(Using data for many firms provides evidence
as to whether the impact of the event is more
than just a one-time occurrence for a single
firm.) Cumulative abnormal returns, repre­
senting the sum of the average abnormal re­
turns to a point in time, show the impact of the
event over time. If the equities market does not
anticipate an event, the cumulative average
abnormal returns up to the event date should
be approximately zero.
In Figure 1, Panel A shows what the cumu­
lative abnormal returns would look like for an
event that has a one-time positive impact on
stock returns. The cumulative abnormal re­
turns are zero until the event date, plotted as
Day 0; on the event date, the abnormal returns
jump. Panel B, on the other hand, shows the
event having a one-time negative impact. In
both panels, however, the event has a lasting
effect in that the cumulative abnormal returns
do not return to zero. If the event is antici­
pated, the pattern of cumulative abnormal
returns would look like Panel C; here, the
returns start to move up several days before
the event date, then jump on the event date.
Analysis of the Data. The final step in the
event-study process is to interpret the abnor­
mal returns data. The examples plotted in
Figure 1 are not taken from actual data. But the
data plotted in Figures 2 and 3 (pp. 20 and 21)
are from actual, and fairly typical, event stud­
ies. In Figure 2, we see the impact of a decision
in a major lawsuit on two firms' abnormal
returns. In Panel B, the cumulative abnormal



Robert Schweitzer

FIGURE 1

Plots of Cumulative
Average Abnormal Returns
(CAARs)

19

BUSINESS REVIEW

JULY/AUGUST 1989

turns indicating that the
event has a positive effect
Cumulative Average Abnormal Returns
on stock returns for one
group of banks. Focusing
(CAARs)
on the event date, Day 0,
we see that the returns tend
% CAARs
to increase about 27 days
0.1
before the event and that
the positive effect is still
♦H'MHi i {i n n i u 111111
present 30 days after the
event. That the pattern of
returns increases before the
event indicates that the
market anticipated this
event.
The bottom panel of
Figure 3 shows the pattern
-10
0
10
20 Days
of returns that might de­
(Event Date)
velop
if the event had a
% CAARs
negative
impact on the stock
0.5
of
another
group of banks.
Days Before
Days After
Note that the cumulative
returns drop sharply before
the event date. This pattern
indicates that the market
reacted negatively to the
event even before it was
announced.
After examining the
- 0.1
plot of the abnormal returns,
-20
-10
0
10
20 Days
financial economists then
(Event Date)
ask whether the pattern of
returns is statistically sig­
SOURCE: Fields, M. Andrew, "The Shareholder Wealth Effects of the TexacoPenzoil Court Case," University of Delaware Working Paper (1988).
nificant or whether it is at­
tributable to chance. To
returns show that the decision has a positive arrive at this answer, economists perform sta­
impact on the one firm's stock. On the other tistical tests on the abnormal returns data, seeking
hand, Panel A shows a negative impact on the evidence to support their financial theories
about the event's economic significance.1
stock of the other firm.
Shortcomings of the Event-Study Approach.
Figure 3 shows the impacts, on two different
groups of banks, of a regulatory change— an The event-study approach is not without its
anticipated event. The cumulative abnormal
returns are plotted for 30 days before and after
the event, itself shown as Day 0. The top panel
’The details of the statistical tests are presented in
of Figure 3 shows cumulative abnormal re­ Brown and Warner (1980) and (1985).

20


FIGURE 2

FEDERAL RESERVE BANK OF PHILADELPHIA

How Do Stock Returns React to Special Events?

Robert Schiveitzer

critics. Financial economists
FIGURE 3
cite several shortcomings.
Cumulative Average Abnormal Returns
First, if researchers are
unable to identify the exact
(CAARs)
event date, they could end
% CAARs
up looking at the wrong
0.07
pattern of abnormal returns
and attribute, incorrectly, a
0.06
stock's response to a spe­
0.05
cific event. Then again, they
0.04
may not observe any trend
in the pattern of returns at
0.03
all.
0.02
In some event studies,
0.01
establishing the exact date
1...........1...........
0.00
of the event can be very
-10
0
10
difficult. In studies of leg­
(Event Date)
islative events, for example,
% CAARs
financial economists gener­
0.00 p .
ally have trouble determin­
ing which date to focus on.
New laws are often dis­
cussed before they are in­
troduced, and there is usu­
ally a considerable period
of debate. Moreover, the
impact of the legislative
change, because of its news­
worthiness, will be recog­
-10
0
10
20 30 Days
nized by investors and af­
(Event Date)
fect stock prices even be­
fore the bill actually becomes
SOURCE: Black, Harold, M. Andrew Fields, and Robert Schweitzer, "Changes
law. A way around this
in Interstate Banking Laws: The Impact on Shareholder Wealth," Working
Paper #88-16, Federal Reserve Bank of Philadelphia (November 1988).
problem is to look at an event
"window" framing the pos­
sible event date within a period of several days. mergers around the same time as the unex­
A second shortcoming is data contamina­ pected earnings announcements, it would be
tion by other events, which makes the results difficult to determine if the abnormal returns
of event studies difficult to interpret. The were attributable to the merger or to the unex­
confounding of several events often enters into pected earnings announcements.
event studies, particularly when the event date
The third shortcoming is the difficulty of
is difficult to determine. For example, we estimating what the firm's normal returns would
might study the effect on firms' stock prices of be in the absence of the event itself. The firm's
announcements of unexpected earnings changes. stock price could have changed because of
But if some of the firms were involved in factors unrelated to the market's movement or



21

BUSINESS REVIEW

to the event itself. For example, banks' stock
prices may change because of general interestrate movements in ways different from those
of nonbanking firms. Complex modeling of the
normal returns can improve the accuracy of the
estimates.2
WHAT CAN WE LEARN
FROM EVENT STUDIES?
Event studies have been done for a wide
range of issues, only some of which will be
reviewed here. (See the Bibliography, pp. 2729, for a detailed list of event studies, by topic.)
Financial economists have studied the effects
of single and multiple events, including merg­
ers and acquisitions, regulatory changes, an­
nouncements of changes in capital structure,
and announcements of bad news. The studies
covered here, focusing on investigations in the
fields of corporate finance and banking, help
illustrate how much stock returns can be af­
fected by announcements of new information.
Announcements of Capital Structure
Changes. Financial economists have grappled
for some time with the issue of optimal capital
structure—that is, whether a firm's capital struc­
ture (its mix of equity and debt) affects its
value. Recent financial research indicates there
might be an optimal capital structure for the
firm.3Thus, changes in capital structure, which
represent changes in a company's leverage
position, could be reflected in a firm's stock
returns. Firms employ financial leverage when
they use debt, which has a fixed interest cost,
rather than equity (common stock) to finance
their operations. A firm's announcement of its

2Kane and Unal (1988) discuss the problems of estimat­
ing normal returns and offer solutions involving more ad­
vanced techniques.
3For more details on the optimal capital structure litera­
ture, see Thomas Copeland and Fred Weston, Financial
Theory and Corporate Policy, 3rd edition, chapters 13 and 14
(Reading, MA: Addison-Wesley Publishing Co., 1988).

Digitized 22
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JULY/AUGUST 1989

intentions to issue new debt or equity therefore
signals information to the financial markets
about that firm to which investors might react.
Several event studies examine the impact of
firms' intentions to issue new securities.4 These
studies test the impact on stock returns of
leverage-changing capital structure adjustments,
and all conclude that the market sees the an­
nouncement to issue new equity as bad news.
The research shows statistically significant
negative abnormal returns (about 3 percentage
points, on the announcement date) associated
with the leverage-decreasing events of selling
new equity or repurchasing debt. A 3-percentage-point change would mean, for example, a
drop in returns from, say, 11 percent to 8
percent. The research on leverage-increasing
events, such as the announcement to issue new
debt, is inconclusive. Most of these studies
report results that are not statistically signifi­
cant, suggesting that the market does not re­
spond to leverage-increasing events in the same
way as it does to leverage-decreasing events.
The impact of capital structure changes on
stock returns for bank holding companies has
attracted recent attention because of the adop­
tion of risk-based capital standards. These
new capital standards will require bank hold­
ing companies (BHCs) to hold different amounts
of capital based on the riskiness of their assets
and off-balance-sheet activities.5 To meet these
new capital-to-asset ratio standards, some BHCs
will be required to issue new equity.

4See Kolodny and Suhler (1985), Masulis and Korwar
(1985), Asquith and Mullins (1986), and Mikkelson and
Partch (1986).
5The details of the new risk-based capital standards are
presented in Robert Avery and Allen Berger, "Risk-Based
Capital and Off-Balance-Sheet Activities," Finance and
Economics Discussion Series (FEDS) #35, Board of Gover­
nors of the Federal Reserve (1988); and Jeffrey Bardos, "The
Risk-Based Capital Agreement: A Further Step Towards
Policy Convergence," Federal Reserve Bank of New York
Quarterly Review (Winter 1987-88) pp. 26-34.

FEDERAL RESERVE BANK OF PHILADELPHIA

How Do Stock Returns React to Special Events?

Applying the event-study approach to re­
turns for 36 major bank holding companies,
James Wansley and Upinder Dhillon (forth­
coming) tested the impact of announcements
by major bank holding companies about ad­
justments in their capital structure. Their re­
sults showed that banks' stock returns display
the same negative reaction to new equity issues
that was found for industrial firms. However,
the negative reaction reported for banks was
only around 1.5 percentage points, compared
to 3 percentage points for industrial firms. The
size of the negative reaction for banks, though,
is closer to the negative reaction of almost 1
percentage point that Paul Asquith and David
Mullins (1986) reported for utility firms.
Mergers and Acquisitions. Event studies
have also been used to analyze the impact of
mergers on firms' returns. Research by
Michael Jensen and Richard Ruback (1983) shows
that the shareholders of targeted firms gain
substantial, and statistically significant, posi­
tive abnormal returns of almost 30 percentage
points. In the case of unsuccessful merger
attempts, shareholders of targeted firms gained
some positive returns when the merger was
initially announced, but lost these gains when
it became clear that the merger would not go
through. As for the bidding or acquiring firms,
studies yield no evidence that mergers increase
their returns.
The effect of interstate bank mergers on
banks' stock returns was investigated by Jack
Trifts and Kevin Scanlon (1987), who report
significant positive abnormal returns for the
acquired or target banks. The share prices of
acquired banks, in fact, were found to increase
around 20 percent. For the acquiring banks,
however, the research failed to show signifi­
cant abnormal returns, as was the case for
industrial firms.
In a study that used a sample larger than
that of Trifts and Scanlon, Marcia Cornett and
Sankar De (1988) studied 153 bank merger bids
and reported significant positive abnormal



Robert Schweitzer

returns both for the target bank and for the
bidding bank. They reported a gain of 9 per­
cent for shareholders of the acquired banks—not
nearly as large as the 20 percent increase in
share price reported by Trifts and Scanlon.
Nonetheless, the evidence is strong and very
convincing that shareholders of acquired banks
do gain in interstate bank mergers.
Bank Regulatory Changes. Because changes
in laws and regulations can influence the way
firms operate and thus affect firms' earnings,
they could alter firms' abnormal returns. Larry
Dann and Christopher James (1982) investi­
gated the removal of deposit interest rate ceil­
ings on the stock prices of stock-owned S&Ls.
They detected a negative cumulative abnormal
return of 8 percentage points 15 days after the
change in interest rate ceilings. This is not sur­
prising, since thrift institutions received net
benefits from regulated deposit rates in the
form of a lower cost of funds. As a result, the
benefits of these reduced-cost deposits should
have been capitalized in thrifts' share prices;
thus, when deposit rate ceilings were removed,
thrifts' share prices fell.
In another study focusing on the banking
industry, Michael Smirlock (1984) examined
the removal of the ceilings on deposit interest
rates in the 1970-78 period to see if bank stock
returns reacted to this deregulatory event. Using
a data set of 17 large banks listed on the major
stock exchanges, Smirlock found that bank
stock returns were unaffected by the removal
of interest rate ceilings. This finding is in
contrast to the Dann and James results for
S&Ls; however, we must remember that this
study focused on larger banks, which were not
as dependent on rate-ceiling-protected depos­
its for funding.
Bad-News Announcements in Banking.
When a firm faces some bad news that substan­
tially alters the prospects for its earnings or its
riskiness, investors typically react quickly by
bidding down the price of its stock. But not all
bad news affects firms' stock prices to the same
23

BUSINESS REVIEW

degree. Analysts have begun to use event
studies to determine the extent of stock re­
turns' reactions to announcements of bad news.
Many examples of bad-news events can be
found in the banking literature. Looking at
three different bank failures—U.S. National
Bank of San Diego in 1973, Franklin National
Bank of New York in 1974, and Hamilton Na­
tional Bank of Tennessee in 1976—Joseph
Aharony and Itzhak Swary (1983) assessed the
reaction of bank stock returns using a data
sample of other banks' stock returns. The
sample included 73 commercial banks: the 12
money-center banks, 31 medium-sized banks
(with total deposits of around $5 billion), and
30 smaller banks (total deposits around $1 bil­
lion). The stock prices of these banks showed
little response to the announcement of the three
bank failures.
Later, Robert Lamy and G. Rodney Thompson
(1986) studied the announcement effects asso­
ciated with the 1982 failure of Penn Square
Bank of Oklahoma. They reported a significant
negative abnormal return of about 1 percent­
age point, on the day Penn Square was closed,
for a sample of 54 major banks all traded on the
New York or American stock exchanges—a
result that could be linked to the market's
perception that Penn Square, at the time of its
failure, had complex lending relationships with
many money-center banks. Thus, the failure of
Penn Square, though only a medium-sized bank,
had adverse implications simply because of its
relationships with other, much larger banks.
In another study, Swary (1986) investigated
the market's reaction to the bad-news announce­
ment in 1984 that Continental Illinois National
Bank was in financial distress. This event
study, conducted on a portfolio of large banks,
found significant negative abnormal returns
(approximately 3 percentage points) following
the news of Continental's problems. These
returns could be explained by investors' down­
ward valuation of other banks' stock. This
revaluation might have occurred because in­
Digitized24for FRASER


JULY/AUGUST 1989

vestors believed that depositors, especially
uninsured depositors, would have less confi­
dence in major banks, and this loss of confi­
dence would increase the cost of funds for
these banks. An increase in their cost of funds
would put downward pressure on banks' earn­
ings.
Another bad-news event that attracted con­
siderable attention was Citicorp's announce­
ment in 1987 that it had increased its loan-loss
reserves to offset potential defaults on its Latin
American loans. Theoharry Grammatikos and
Anthony Saunders (1988) studied the impact of
this event and the announcements made subse­
quently by other major American banks having
large Latin American loan portfolios. Using a
sample of 112 U.S. banks, the researchers found
that the Citicorp announcement had only a
weak negative effect on other banks' returns.6
Meanwhile, another study, conducted on
the 12 major money-center banks by Jeff Madura
and William McDaniel (forthcoming), showed
that the market for bank stocks had anticipated
the Citicorp announcement. In yet another
study, by James Musumeci and Joseph Sinkey
(1988), the effect of the announcement was
found to be significantly positive for Citicorp
and a sample of 25 large bank holding compa­
nies. All these studies show that Citicorp's
announcement had effects on other major banks
much like previous studies showing the news
of bank failures in the 1980s having an effect on
major banks.
SUMMARY
Event studies such as those just described
provide investors, financial managers, and
regulators with new data about how firms'
stocks behave and about how quickly new

6The effect of subsequent announcements by other
banks, however, was found to differ across banks in the
sample; some experienced large negative abnormal returns
while others had positive abnormal returns. The study
therefore reports that no general conclusions can be drawn.

FEDERAL RESERVE BANK OF PHILADELPHIA

How Do Stock Returns React to Special Events?

Robert Schweitzer

Event-study research might prove useful as
well in helping to assess the impact on bank
holding companies' stock prices when some
BHCs issue new capital to meet the new riskbased capital standards. All these examples of
event studies suggest that the methodology
will likely continue to have widespread uses in
the fields of banking and finance.

information affects firms' stock returns. Such
studies have helped document the extent to
which the shareholders of acquired firms or
acquired banks gain abnormal returns in merg­
ers. They also have helped identify and quan­
tify cases in which bad news affecting one bank
or group of banks has had so-called contagion
effects on other banks.

Estimating Returns
To conduct an event study the analyst must measure a security's performance against a bench­
mark. The benchmark is usually the return that the security would have achieved had the event not
occurred. Thus, the key to this analysis is to determine a model of the return-generating process for
the security in question.
Several methods have been used to model the return-generating process. The simplest way is by
mean-adjusted returns. Under this approach the abnormal returns would be:
AR = R - R
where:

j‘

)‘

( 1)

)

ARjt is the abnormal return on the security of firm j in time period t,
R.( is the observed return on the security of firm j in time period t, and
R. is the mean return for the security of firm j over a given sample period.
This technique assumes that the expected returns for a firm's security are constant and equal to
the historical average return and, thus, that any changes from the mean should be abnormal returns.
Another simple approach involves market-adjusted returns. Here it is assumed that the
abnormal returns are those that are above the market return. Under this approach the abnormal
returns would be:
AR = R - Rmt
( 2)
j*

jt

where Rmt is the return on the market portfolio in time period t. Financial economists usually use
an index return, such as the Standard & Poor's 500-stock index, for the market return.
Most event studies employ a more complicated return-generating process called the market
model. In this model the returns for a security are assumed to be linearly related to the returns on
the market. The market model requires the analyst to estimate the parameters of the following
equation using regression analysis:

+

(3)

where a, p are regression parameters, and e.( is the error term for tirjie period t. Once these regression
parameters are estimated, ^he security's normal returns (called Rjt) are then estimated using the
estimated parameters (a, (3) and the return on the market by substituting into equation (3)




25

JULY/AUGUST 1989

BUSINESS REVIEW

A A

(R.,jt = a+ rB Rm tX The abnormal returns are the difference between the estimated normal returns to the
actual:
A R ( = R - R.
(4)
jt
j‘
)‘
where Rjt is the estimated return for time period t from the regression equation .* This approach rec­
ognizes that few stocks move one-for-one with the overall market.
Once the abnormal returns have been estimated, the cross-section average abnormal returns are
then calculated. They are:
N
AAR t = I A R jt / N
(5)

j=1

where AARt is the average abnormal return for time period t, and N is the number of firms in the
study. The average abnormal returns are then summed to find the cumulative average abnormal
returns. They are:
CAARt = AARt + CAAR m
(6)
where CAAR( is the cumulative average abnormal return for time period t.

*For more details on these approaches, see Brown and Warner (1980) and (1985).


26


FEDERAL RESERVE BANK OF PHILADELPHIA

How Do Stock Returns React to Special Events?

Robert Schweitzer

Selected Bibliography
This selected bibliography includes examples of event studies from the corporate finance and bank­
ing literature. The selections are organized by type of event.

Bad-News Events
Grammatikos, Theoharry, and Anthony Saunders. "Additions to Bank Loan-Loss Reserves: Good
News or Bad News?," New York University Working Paper (March 1988).
Madura, Jeff, and William McDaniel. "Market Reaction to Increased Loan-Loss Reserves at MoneyCenter Banks," Journal of Financial Services Research (forthcoming).
Musumeci, James, and Joseph Sinkey. "The International Debt Crisis and the Signalling Content of
Bank Loan-Loss-Reserve Decisions," University of Georgia Working Paper (August 1988).
Pruitt, Stephen, and David Peterson. "Security Price Reactions Around Product Recall Announce­
ments," Journal of Financial Research 9 (Summer 1986) pp. 113-22.

Capital Structure
Asquith, Paul, and David Mullins. "Equity Issues and Offering Dilution," Journal of Financial Econom­
ics 15 (Ja n u a ry /F e b ru a ry 1986) pp. 61-89.
Keeley, Michael. "The Stock Price Effects of Bank Holding Company Securities Issuance," Federal
Reserve Bank of San Francisco Economic Review (Winter 1989) pp. 3-19.
Kolodny, Richard, and Diane Rizzuto Suhler. "Changes in Capital Structure, New Equity Issues, and
Scale Effects," Journal of Financial Research 8 (Summer 1985) pp. 127-136.
Masulis, Ronald, and Ashok Korwar. "Seasoned Equity Offerings: An Empirical Investigation,"
Journal of Financial Economics 15 (January/February 1986) pp. 91-118.
Mikkelson, Wayne, and M. Megan Partch. "Valuation Effects of Security Offerings and the Issuance
Process," Journal of Financial Economics 15 (January/February 1986) pp. 31-60.
Modigliani, Franco, and Merton Miller. "The Cost of Capital, Corporation Finance, and the Theory
of Investment," American Economic Review 48 (June 1958) pp. 261-97.
Modigliani, Franco, and Merton Miller. "Corporate Income Taxes and the Cost of Capital: A
Correction," American Economic Review 53 (June 1963) pp. 433-43.
Wansley, James, and Upinder Dhillon. "Determinants of Valuation Effects for Security Offerings of
Commercial Bank Holding Companies/'Journal of Financial Research (forthcoming).




27

BUSINESS REVIEW

JULY/AUGUST 1989

Dividends and Earnings Announcements
Aharony, Joseph, and Itzhak Swary. "Quarterly Dividend and Earnings Announcements and
Stockholders' Returns: An Empirical Analysis," Journal of Finance 35 (March 1980) pp. 1-12.
Asquith, Paul, and David Mullins. "The Impact of Initiating Dividend Payments on Shareholders'
Wealth," Journal of Business 56 (January 1983) pp. 77-96.
Brickley, James. "Shareholder Wealth, Information Signaling and the Specially Designated Dividend:
An Empirical Study," Journal of Financial Economics 12 (August 1983) pp. 187-209.
Fama, Eugene, and others. "The Adjustment of Stock Prices to New Information," International
Economic Review 10 (February 1969) pp. 1-21.
Keen, Howard. "The Impact of a Dividend Cut Announcement on Bank Share Prices," Journal of Bank
Research 13 (Winter 1983) pp. 274-81.
Myers, Stewart, and Nicholas Majluf. "Corporate Financing and Investment Decisions When Firms
Have Information That Investors Do Not Have," Journal of Financial Economics 13 (June 1984) pp. 187-

221.
Pettit, R. Richardson. "Dividend Announcements, Security Performance, and Capital Market
Efficiency," Journal of Finance T7 (December 1972) pp. 993-1007.

Event-Study Methodology
Bowman, Robert. "Understanding and Conducting Event Studies," Journal of Business Finance and
Accounting 10 (December 1983) pp. 561-84.
Brown, Stephen, and Jerold Warner. "Measuring Security Price Performance," Journal of Financial
Economics 8 (September 1980) pp. 205-58.
Brown, Stephen, and Jerold Warner. "Using Daily Stock Returns: The Case of Event Studies," Journal
of Financial Economics 14 (March 1985) pp. 3-31.
Kane, Edward, and Haluk Unal. "Change in Market Assessments of Deposit-Institution Riskiness,"
Journal of Financial Services Research 1 (June 1988) pp. 207-29.
Madura, Jeff. "Banking Event Studies: Synthesis and Directions for Future Research," Florida
Atlantic University Working Paper (1988).

Mergers and Acquisitions
Cornett, Marcia, and Sankar De. "An Examination of Stock Market Reactions to Interstate Bank
Mergers," Southern Methodist University Working Paper (September 1988).
Jensen, Michael, and Richard Ruback. "The Market for Corporate Control: The Scientific Evidence,"
Journal of Financial Economics 11 (April 1983) pp. 5-50.

Digitized 28
for FRASER


FEDERAL RESERVE BANK OF PHILADELPHIA

How Do Stock Returns React to Special Events?

Robert Schweitzer

Trifts, Jack, and Kevin Scanlon. "Interstate Bank Mergers: The Early Evidence," Journal of Financial
Research 10 (Winter 1987) pp. 305-11.

Problem Banks
Aharony, Joseph, and Itzhak Swary. "Contagion Effects of Bank Failures: Evidence from Capital
Markets," Journal of Business 56 (July 1983) pp. 305-22.
Lamy, Robert, and G. Rodney Thompson. "Penn Square, Problem Loans, and Insolvency Risk,"
Journal of Financial Research 9 (Summer 1986) pp. 103-11.
Swary, Itzhak. "Stock Market Reaction to Regulatory Action in the Continental Illinois Crisis,"
Journal of Business 59 (July 1986) pp. 451-73.

Regulation
Aharony, Joseph, and Itzhak Swary. "Effects of the 1970 Bank Holding Company Act: Evidence from
Capital Markets," Journal of Finance 36 (September 1981) pp. 841-53.
Binder, John. "Measuring the Effects of Regulation with Stock Price Data," Rand Journal of Economics
16 (Summer 1985) pp. 167-83.
Dann, Larry, and Christopher James. "An Analysis of the Impact of Deposit Rate Ceilings on the
Market Values of Thrift Institutions," Journal of Finance 37 (December 1982) pp. 1259-75.
Smirlock, Michael. "An Analysis of Bank Risk and Deposit Rate Ceiling: Evidence from the Capital
Markets," Journal of Monetary Economics 13 (March 1984) pp. 195-210.

Strategic Decisions
Eisenbeis, Robert, Robert Harris, and Josef Lakonishok. "Benefits of Bank Diversification: The
Evidence from Shareholder Returns," Journal of Finance 39 (July 1984) pp. 881-92.
Hite, Gailen, and James Owers. "Security Price Reactions Around Corporate Spin-off Announce­
ments," Journal of Financial Economics 12 (December 1983) pp. 409-36.
McConnell, John, and Chris Muscarella. "Corporate Capital Expenditure Decisions and the Market
Value of the Firm," Journal of Financial Economics 14 (September 1985) pp. 399-422.
Saunders, Anthony, and Michael Smirlock. "Intra- and Interindustry Effects of Bank Securities
Market Activities: The Case of Discount Brokerage," Journal of Financial and Quantitative Analysis 22
(December 1987) pp. 467-82.
Schipper, Katherine, and Abbie Smith. "Effects of Recontracting on Shareholder Wealth: The Case
of Voluntary Spin-offs," Journal of Financial Economics 12 (December 1983) pp. 437-67.
Zaima, Janis, and Douglas Hearth. "The Wealth Effects of Voluntary Selloffs: Implications for Divest­
ing and Acquiring Firms," Journal of Financial Research 8 (Fall 1985) pp. 227-36.



29

Philadelphia/RESEARCH

Working Papers

.

The Philadelphia Fed's Research Department occasionally publishes working papers based on the
current research of staff economists. These papers, dealing with virtually all areas within economics and
finance, are intended for the professional researcher. Papers added to the Working Papers Series in 1988
and the first half of 1989 are listed below.
A complete list of all available working papers may be ordered from WORKING PAPERS, Department
of Research, Federal Reserve Bank of Philadelphia, 10 Independence Mall, Philadelphia PA 19106-1574.
Copies of papers may be ordered from the same address. For overseas airmail requests only, a $2.00 per
copy prepayment is required.

1988
No. 88-1

Mitchell Berlin and Loretta J. Mester, "Credit Card Rates and Consumer Search."

No. 88-2

Loretta J. Mester, "An Analysis of the Effect of Ownership Form on Technology: Stock
Versus Mutual Savings and Loan Associations."

No. 88-3

David Y. Wong, "Inflation, Taxation, and the International Allocation of Capital."

No. 88-4

Richard Voith and Theodore Crone, "Natural Vacancy Rates and the Persistence of Shocks
in U.S. Office Markets."

No. 88-5

Paul S. Calem and Gerald A. Carlino, "Agglomeration Economies and Technical Change in
Urban Manufacturing."

No. 88-6

Peter Linneman and Richard Voith, "Concentration, Prices, and Output in the Automobile
Industry."

No. 88-7

Brian J. Cody, "Exchange Controls, Political Risk and the Eurocurrency Market: New
Evidence From Tests of Covered Interest Rate Parity."

No. 88-8

Peter Linneman and Richard Voith, "Housing Price Functions and Ownership Capitaliza­
tion Rates."

No. 88-9

Robert H. DeFina, "Employee Turnover and Regional Wage Differentials."

No. 88-10

David Y. Wong, "What Do Saving-Investment Relationships Tell Us About Capital
Mobility?"

No. 88-11

John F. Boschen and Leonard O. Mills, "Testing For Cointegration in the Presence of Moving
Average Errors."

No. 88-12

Paul S. Calem, "On Gradual Price Reduction as a Retail Sales Strategy."

No. 88-13/R Loretta J. Mester, "A Testing Strategy for Expense Preference Behavior." (Revision of No.
88-13.)
No. 88-14/R

Loretta J. Mester, "Agency Costs in Savings and Loans." (Revision of No. 88-14.)

William W. Lang and Leonard I. Nakamura, "Information Losses in a Dynamic Model of
No.
88-15

http://fraser.stlouisfed.org/ Credit."
Federal Reserve Bank of St. Louis

No. 88-16

Harold A. Black, M. Andrew Fields, and Robert Schweitzer, "Changes in Interstate Banking
Laws: The Impact on Shareholder Wealth."

No. 88-17

Sherrill Shaffer, "Structural Shifts and the Volatility of Chaotic Markets."

No. 88-18

Sherrill Shaffer, "Contestable Two-Part Tariffs With Income Effects."

No. 88-19

Behzad T. Diba and Seonghwan Oh, "Have Money-Stock Fluctuations Had a Liquidity
Effect on Expected Real Interest Rates?"

No. 88-20

Loretta J. Mester, "Credit Card Stickiness in a Screening Model of Consumer Credit."

No. 88-21

Loretta J. Mester, "Viability in Multiproduct Industries." (Supersedes "Competitive
Viability in Banking.")

No. 89-1

Sherrill Shaffer, "Pooling Intensifies Joint Failure Risk."

No. 89-2

Brian J. Cody, "Optimal Exchange Market Intervention: Evidence From France and West
Germany During the Post-Bretton Woods Era."

No. 89-3

James J. McAndrews, "Strategic Role Complementarity."

No. 89-4

Douglas Holtz-Eakin and Harvey S. Rosen, "Intertemporal Analysis of State and Local
Government Spending."

No. 89-5

Brian J. Cody and Leonard O. Mills, "Evaluating Commodity Prices as a Gauge for Monetary
Policy."

No. 89-6

Sherrill Shaffer, "Can the End User Improve an Econometric Forecast?"

No. 89-7

Theoharry Grammatikos and Anthony Saunders, "Additions to Bank Loan-Loss Reserves:
Good News or Bad News?"

No. 89-8

Behzad T. Diba and Seonghwan Oh, "Money, Inflation, and the Expected Real Interest
Rate."

No. 89-9

Linda Allen and Anthony Saunders, "Incentives to Engage in Bank Window-Dressing:
Manager vs. Stockholder Conflicts."

No. 89-10

Ben S. Bernanke and Alan S. Blinder, "The Federal Funds Rate and the Channels of Monetary
Transmission."

No. 89-11

Leonard I. Nakamura, "Loan Workouts and Commercial Bank Information: Why Banks Are
Special."

No. 89-12

William W. Lang, "An Examination of Wage Behavior in Macroeconomic Models with

1989


Long-Term Contracts."


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