Debt and Crises

Paper Session

Friday, Jan. 6, 2017 8:00 AM – 10:00 AM

Sheraton Grand Chicago, Chicago Ballroom X
Hosted By: American Finance Association
  • Chair: Efraim Benmelech, Northwestern University

Credit Spreads and the Severity of Financial Crises

Arvind Krishnamurthy
Stanford University
Tyler Muir
Yale University


We study the behavior of credit spreads and their link to economic growth during
financial crises. We find that the recessions that accompany financial crises are severe
and protracted. The severity of the crisis can be forecast by the size of credit losses
(change in spreads) coupled with the fragility of the financial sector (as measured by
pre-crisis credit growth). We also find that spreads fall in the runup too a crisis and
are abormally low, even as credit grows ahead of a crisis. That is, a crisis involves a
dramatic shift in expectations and is a surprise.

Why Does Fast Loan Growth Predict Poor Performance for Banks?

Rudiger Fahlenbrach
Swiss Federal Institute of Technology-Lausanne
Robert Prilmeier
Tulane University
Rene M. Stulz
Ohio State University


From 1973 to 2014, the common stock of U.S. banks with loan growth in the top quartile of banks over a three-year period significantly underperforms the common stock of banks with loan growth in the bottom quartile over the next three years. After the period of high growth, these banks have a lower return on assets and increase their loan loss reserves. The poorer performance of fast growing banks is not explained by merger activity. The evidence is consistent with banks, analysts, and investors being overoptimistic about the risk of loans extended during bank-level periods of high loan growth.

Inefficient Banking

Juliane Begenau
Harvard Business School
Erik Stafford
Harvard University


The core banking activities of extending and monitoring loans and issuing low yielding short-term liabilities are functionally similar to investing in high quality credit and maturity spread trades funded with short-term brokerage loans in the capital market. We find that the unlevered return on assets for the US aggregate banking sector has averaged 2.7% per year over 1999-2015, while similar exposures sourced passively in the capital market earn 3.7% per year. Banks that underperform their size and asset risk matched peers tend to use higher leverage to increase their return on equity. The stock market rewards these banks with high valuations.
Egon Zakrajsek
Federal Reserve Board
Samuel Hanson
Harvard Business School
Efraim Benmelech
Northwestern University
JEL Classifications
  • G2 - Financial Institutions and Services