Securitization and the Term Structure of Interest Rates: The Long and Short of It

This dissertation investigates whether U.S. commercial banks substitute fee-based income for the decreases in net interest income brought about by a flattening term structure of interest rates. Given the current economic climate, the fee-based activity of interest is asset securitization, though a number of other specific fee-based income-generating activities, such as service charges on deposit accounts, are considered as well. Using a combination of quarterly bank-specific and macroeconomic data from 2001:1 to 2008:1, both the fixed-effects and Arellano-Bond techniques are used to estimate the effect of the term structure on various bank outcomes. It is revealed that while large banks, those with real assets of $10 billion or more, do not see significant decreases in net interest income when the term structure flattens, they do significantly increase the proportion of total assets securitized. This indicates that prior to the subprime mortgage crisis, a narrowing difference between long and short rates led to this group of banks packaging and distributing the assets that would eventually deteriorate in value. Moreover, large banks did not significantly alter their capital levels upon asset securitization, regardless of asset type, as theory would imply. Given that large banks increased their aggregate securitization activity when the term structure flattened, proposed legislation with the intent to shrink bank size in order to prevent future economic crises is not entirely without merit. However, breaking up banks with respect to either operations or geography could result in institutions of relatively higher overall risk. Going hand-in-hand with this is the `too big to fail' phenomenon. In the quest to prevent government intervention when large, interconnected banks show signs of potential failure, it may be that the best policy alternative is to complement the status quo with a resolution mechanism that minimizes collateral damage to both Wall Street and Main Street.