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A Tale of Cities and Mortgages |
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That is, have the decade's developments caused banking markets to grow beyond cities and rural localities to become regional or national in scope? This question is particularly important with respect to bank mergers and acquisitions: If banking markets are non-local, then supply and demand conditions in a locality should not affect prices in that locality; therefore, such local conditions would not be relevant in the evaluation of the competitive effects of any given merger. This study conducts an empirical test of the issue by examining whether local market concentration and other local market conditions have a systematic influence on mortgage loan interest rates, that is, on the price of mortgage loans. A by-product of this analysis is a test of the price-concentration relationship, which is a hotly debated element in general antitrust analysis. The study analyzes more than 13,500 observations of mortgage loan interest rate terms and non-interest rate terms covering a 16-week period for 20 U.S. cities from late 1987 through early 1988. It has been argued that, of all banking services, mortgage lending has been the most affected by developments that tend to widen geographic markets, based on the fact that such mortgage loans represent by far the largest and longest-term financial service purchase a prominent claim. Consumers, therefore, presumably are more willing to incur greater transaction costs for a low-cost mortgage than to obtain other financial services because the returns on searching are likely to be greatest for mortgage loans. This behavior generally expands the size of the geographic market and drives mortgage loan interest rates toward a competitive level. Furthermore, in recent years, mortgage loans have been packaged as the basis for mortgage-backed securities, which are sold in national markets, as are mortgage loans themselves--for many years, local originators have sold them off to large permanent investors located in major cities. These arguments suggest that mortgage loan rates should provide a relatively stringent test of the proposition that the market for banking services is local. That is, mortgage loans have probably been subject to more forces conducive to a geographic broadening of the market than most other bank services; consequently, a finding that mortgage loan rates are still determined by local market factors is probably a good indication that the market for consumer-oriented banking services in general is local in nature. A finding that the mortgage loan market is local would also be particularly striking because of the nature of this study's statistical sample, which consists entirely of urban areas. Urban locations typically have far more competitors than non-urban areas, and competition is generally one of the factors determining price differences between markets. Thus, a sample characterized by a relatively high degree of competition should bias the result of a test for price differentiation toward uniformity of prices. Data on the interest rates (prices) banks charge for their mortgage loans are not generally available. Listings of mortgage loan rates, however, are fairly common in newspapers throughout the country. Therefore, to construct a sample, this study recorded mortgage loan rates for the sixteen weeks from September 20, 1987, through January 9, 1988, as they appeared in weekly listings published in newspapers in 20 cities. The 20 cities were selected more or less randomly, although some choices were made to achieve a degree of geographic diversity. The listings covered 1,039 mortgage loan loan-lending institutions, which, over the sixteen weeks, produced 15,286 interest rate observations for fixed-rate, conventional mortgage loans. The sample included all the major types of mortgage loan originators in the United States--commercial banks, savings and mortgage loan associations, savings banks, credit unions, and mortgage loan banks; 873 observations were not classified by type of firm. Most newspaper listings of rates also showed other mortgage loan terms: the percentage down payment required, the length of the mortgage loan, points charged (fee in terms of percentage points of the mortgage loan amount), and the maximum mortgage loan to which the terms apply. The exclusion of observations with missing items left 13,525 observations available for the statistical tests. Both an ordinary-least-squares fixed-market-effects model and an OLS model containing specific market variables indicate that local market conditions influence mortgage loan interest rates. Market growth and per capita income are the most important variables, but the Herfindahl index, a measure of market concentration, also plays a role after controlling for costs. These results for mortgage loans suggest that analyzing bank competition within local geographic markets is still appropriate. That is, local market conditions still make a difference. Moreover, the results suggest that market concentration, as measured by the Herfindahl index, affects the prices charged in local markets for mortgage loans. This would appear to support the traditional market-power explanation for the market structureperformance relationship rather than the Demsetz efficiency explanation. |
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