Tag Archives: MIT Sloan

Rethinking How the Housing Crisis Happened

New research casts into doubt the central storyline of 2008—that this was ever a subprime crisis to begin with.

“In 2006, Robert and Julia Tanner borrowed $30,000 to put an enclosed patio on their home that they had somehow managed to live without for 25 years. Why don’t you ask them about that when they’re spitting in your face while you walk them to the curb? Why don’t you ask the bank what the hell they were thinking giving these people an adjustable rate mortgage? And then you can go to the government and ask them why they listed every other regulation … You, Tanners, the banks, Washington, every other homeowner and investor from here to China turned my life into evictions.”

So Florida businessman Rick Carver lectures a young protégé in “99 Homes,” a 2014 film that casts the late-2000s housing collapse as a morality play. Carver, loaded with unforgiving moral certitude by the actor Michael Shannon, orders the Tanners’ eviction while standing in an empty McMansion. He’s living there part time after evicting the tenants when their mortgage went underwater.

“99 Homes” is littered with ruin. Nobody—the poor, the Tanners, the McMansion dwellers—escapes, or escapes blame for, the crisis. Now research from MIT Sloan finance professor Antoinette Schoar finds this picture more true than is commonly accepted. In fact, Schoar argues, it was middle-class borrowers with good credit who drove the largest number of dollars in default.

“A lot of the narrative of the financial crisis has been that this [loan] origination process was broken and therefore a lot of marginal and unsustainable borrowers got access to funding,” Schoar said in September at the MIT Golub Center for Finance and Policy’s annual conference. “In our opinion, the facts don’t line up with this narrative … Calling this crisis a subprime crisis is a misnomer. In fact, it was a prime crisis.”

Read the full article here>>

Reception Held in Honor of Bengt Holmström, co-recipient of the 2016 Nobel Prize in Economics Sciences

On  Tuesday, November 1st the MIT Sloan Office of the Dean, Finance Group and Applied Economics Group co-hosted a reception in honor of Professor Bengt Holmström. Approximately 175 faculty, students and staff members gathered to congratulate Professor Holmström on being selected as the co-recipient of the 2016 Svergies Riksbank Prize in Economics Sciences in Memory of Alfred Nobel.

Speakers included David Schmittlein, John C Head III Dean, Professor Robert Gibbons, Sloan Distinguished Professor of Management, Professor Stephen Ross, Franco Modigliani Professor of Financial Economics, and Professor Antoinette Schoar, Michael M. Koerner (1949) Professor of Entrepreneurship.

Photos from the event can be viewed here>>

What Your Credit-Card Offers Say About You

See the original article on WSJ Experts page>>

credit_card_finances_gettyAs more and more personal data becomes available, businesses are now able to target customers in a personalized and sophisticated way.  On the bright side, that means you can get products and services that are tailored to your needs. As a result, you are much less likely to get catalogs featuring dresses your grandmother might wear. But, according to our research, the downside is that companies can also more effectively target your behavioral weaknesses, self-control issues or lack of attention to the fine print. We find that credit-card companies tend to offer those customers who are least able to manage the complexity of credit-card contracts, the most complex features and hidden charges.

As part of our research at MIT with my colleague Hong Ru, we recently studied over one million credit-card mailing campaigns that were sent to a representative set of U.S. households from March 1999 to February 2011. We devised algorithms to classify the terms of the credit cards and also the advertising material. Studying the wide variety of offers and who received which offer was illuminating. Credit-card terms offered to more financially sophisticated consumers differ significantly from those offered to less sophisticated customers, where educational attainment served as a proxy for sophistication.

The offers differed in both substance and style.  Less-sophisticated borrowers received offers with low teaser rates, more rewards, visual distractions, and fine print at the end of the offer letter. However, these offers also had more back-loaded and hidden fees. For example, after the introductory period, these cards have higher rates, late fees and overlimit fees.

In contrast, cards that are offered to sophisticated customers rely much less on back-loaded fees and instead have higher upfront fees, such as annual fees.  These cards tend to have higher regular annual percentage rates and often carry an annual fee, but they have low late fees and over-the-limit fees and are more likely to carry airline miles as rewards.

Not surprisingly, the worse the credit terms, the more likely they are to appear either in small font or on the last pages of the offer letters.  Similarly, offer letters with back-loaded terms contain more photos and less text, perhaps to distract from the details of the offer—what we refer to as shrouded attributes.

In fact, we found that banks seem to carefully monitor how the use of such shrouded attributes might affect the likelihood that unsophisticated customers will default on their debts. Our study showed that less-educated consumers who have lower default risk are more subject to back-loaded or shrouded fees. We also found that in states where there was an increase in unemployment insurance benefits that help borrowers maintain more stable cash flows in the event of a job loss, banks issued potential borrowers within that state more offers with lower teaser rates but higher late fees and default penalties. Banks also increased the flashiness of the offer letter, with more colors and photos, but moved the information about the back-loaded features to the end of the letter.

Taken together, these results suggest that credit-card companies realize that there is an inherent trade-off in the use of back-loaded features in credit-card offers: They might induce customers to take on more (expensive) credit, but at the same time, they expose the lender to greater risk if those consumers do not anticipate the true cost of credit.

So what’s the upshot of our study? First, you are lucky if you have a good education, since it means that the set of credit cards you get to choose from is already better from the start. But independent of your educational status, consumers should know that they have the power and information to choose well. Each credit-card offer in the U.S. must by law have a text box that contains all the relevant terms of the offer in one place; this is called the Schumer box after Sen. Chuck Schumer of New York.

So the best way to choose a credit card is to literally throw away all the marketing material at the front of the offer and simply focus on the real information in the Schumer box. This is true no matter what your income or education level.

Antoinette Schoar is the Michael Koerner ’49 professor of entrepreneurial finance and chair of the finance department at the MIT Sloan School of Management.