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Students in Distress: Labor Market Shocks, Student Loan Default, and Federal Insurance Programs

Journal of Financial Economics, R&R

Coauthors: Holger Mueller

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The collapse in home prices during the Great Recession triggered a sharp drop in consumer demand by households, leading to massive employment losses. This paper examines the implications of these labor market shocks for the dramatic rise in student loan defaults, which originated during this time period. Linking administrative student loan data at the individual borrower level to de-identified tax records and exploiting Zip code level variation in home price changes, we show that the drop in home prices during the Great Recession accounts for approximately 24 to 32 percent of the increase in student loan defaults. Consistent with a labor market channel, we find a strong relationship between home prices, employment losses, and student loan defaults at the individual borrower level, which is concentrated among low income jobs. Comparing the default responses of home owners and renters, we find no evidence of a direct liquidity effect of home prices on student loan defaults. Lastly, we show that the Income Based Repayment (IBR) program introduced by the federal government in the wake of the Great Recession reduced both student loan defaults and their sensitivity to home price fluctuations, thus providing student loan borrowers with valuable insurance against adverse income shocks.


Strategic Default on Student Loans

Journal of Finance, R&R

Best Paper Award, FMA Napa Conference on Financial Markets Research 2017

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Student loans finance investments in human capital. Incentive problems arising from lack of collateral in human capital investments have been used to justify the differential bankruptcy and other recovery treatment of student loans, despite a lack of empirical evidence of strategic behavior on the part of student borrowers. This paper uses policy induced variation in non-repayment costs, that is unrelated to liquidity, to test for a strategic component to the non-repayment decision. The removal of bankruptcy protection and increases in wage garnishment reduce borrowers’ incentives to default, providing evidence for a strategic model of non-repayment. The results suggest that rein- troducing bankruptcy protection would increase loan default by 18%, and eliminating administrative wage garnishment would increase default by 50%. Consistent with strategic behavior on the part of borrowers, the incentive effects of bankruptcy are larger for borrowers with large balances, and smaller for very low and high income borrowers. The results provide novel evidence that strategic behavior plays an important role in student loan repayment.


Asymmetric Information in Student Loans

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Student loans finance investments in human capital, and adverse selection and hidden actions can lead to credit limits and inefficient investment. This paper tests for and quantifies information asymmetries in the student loan market. I first identify selection parameters and the causal effect of increased borrowing on loan non-repayment by using (i) non-linearities in borrowing rules for federal student loans and (ii) changes in tuition for students already enrolled. The paper finds that larger loan volumes induce default - a 40% increase in borrowing increases non-repayment by 10%. Adverse selection effects are large in the 1980s when default costs were low, and selection is ad- vantageous in the 2000s following increases in non-repayment costs. Larger loan volumes inducing loan non-repayment is consistent with both strategic and non-strategic models of default. The pa- per uses policy induced variation in non-repayment costs to test for a strategic component in the repayment decision. The removal of bankruptcy protection and increases in wage garnishment re- duce default without affecting pre-default liquidity, providing evidence for strategic non-repayment. Reintroducing student loan bankruptcy discharge would cost approximately $90 billion. Estimates from a decomposition indicate that hidden actions resulting from increased borrowing can explain approximately one quarter of the increase in default in recent years, while most of the rest can be explained by changes in the selection of borrowers and the institution type attended.


Debt and Human Capital: Evidence from Student Loans

Journal of Financial Economics, R&R

Best Paper Award, LBS Summer Finance Symposium 2017

Coauthors: Slava Fos and Andres Liberman

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This paper investigates the dynamic relation between debt and investments in human capital. We document a negative causal effect of the level of undergraduate student debt on the probability of enrolling in a graduate degree for a random sample of the universe of federal student loan borrowers in the US. We compare students (i) within school and cohort, and (ii) across cohorts within the same school at the time of a large tuition change. The latter strategy exploits the fact that students who face a tuition increase in earlier grades end up with significantly more debt than students who face the same tuition increase in later grades. We find that $4,000 in higher debt causes a two percentage point reduction in the probability of enrolling in graduate school relative to a mean of 12%. Further results suggest this effect is largely driven by credit constraints, is monotonically weaker with family income, and is attenuated for students who had compulsory personal finance training in high school. The results highlight an important trade off associated with debt-financing of human capital, and inform the debate on the effects of the large and increasing stock of student debt in the US.

Managerial Ownership and Firm Performance: Evidence From the 2003 Dividend Tax Cut

Coauthors: Xing Li and Stephen Sun

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We identify the causal relationship between managerial ownership and firm performance using the 2003 Dividend Tax Cut as a quasi-natural experiment, which increased the net-of- tax executive managerial ownership. Consistent with predictions from agency theory, we and a significant and hump-shaped improvement in firm performance measured by Tobin's Q due to the tax cut. Moreover, the relation between managerial ownership and firm performance relies on the strength of other co-existing channels of corporate governance. In particular, only firms with weak internal corporate governance proxied by G-Index or E-Index are significantly affected in a hump-shaped manner by the tax cut. At the same time, firms with weak institutional governance increase their performance significantly more. These findings strengthen our interpretation that the improvement in firm performance is due to increased managerial incentive. Our results are robust to examination of pre-trend and placebo tests, accounting measures of firm performance as well as other considerations.


Language Skills and Homophilous Hiring Discrimination: Evidence from Gender and Racially Differentiated Applications

Coauthors: Anthony Edo and Nicolas Jacquemet.

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This paper investigates the importance of ethnic homophily in the hiring discrimination process, and provides a novel test for statistical discrimination. Our evidence comes from a correspondence test performed in France, in which we use three different kinds of ethnic identification: French sounding names, North African sounding names, and “foreign” sounding names with no clear ethnic association. Within both male and female groups, we show that all non-French applicants are equally discriminated against when compared to French applicants – confirming the importance of favoritism for in-group members. Moreover we find direct evidence of homophily: recruiters with European names are more likely to call back French named applicants and female recruiters are more likely to call back women. The paper directly tests for statistical discrimination by adding a signal related to language skill ability in all resumes sent to half the job offers. The design allows us to uniquely identify the effect of the language signal across genders. Signal inclusion significantly impacts the discrimination experienced by non-French females, and is much weaker for male minorities.

Greener on the Other Side: Estimating Consumer Sensitivity to Local Sales Tax Changes

Coauthors: Trevor Davis, Dan Knoepfle, and Stephen Sun

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We estimate the sensitivity of retail sales to sales taxes using policy discontinuities in sales tax rates at state borders using novel national retail sales data. We estimate the border substitution effect of sales taxation and the price elasticity of demand for traditional and internet retailers. Our approach generalizes the case study approach by exploiting a new nationally representative data set and all sales tax changes between 2008 and 2010. We estimate a price elasticity of 5.9 in ZIP codes on state borders, and a price elasticity of 1.7 for internet retail. We find that the effect of sales taxation on retail is largest in geographic areas close to a state border, and sales taxes in neighboring states have no effect on retail activity in geographic areas more than 75 miles away from a state border. The effect is largest for electronics, appliances, and clothing. We find no effect for goods that are not taxed such as services and food.

The Minimum Wage and Employment Dynamics: Evidence from an Age Based Reform in Greece

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This paper analyzes minimum wage employment effects and dynamics using an age-based reform in Greece. In 2012 the minimum wage was reduced differentially for workers above and below age 25. Administrative labor force data, graphical evidence and a difference-in-difference approach are used to identify a negative effect on employment. The bulk of this effect is substitution from older workers to younger workers, however there is also a significant disemployment effect. Identifying elasticities of substitution and comparing younger to older workers yields an employment elasticity of between -.28 and -.46 for young workers. The result is present in several outcome variables including unemployment, full time employment, and hours worked, and is robust to a number of specification and falsification tests. The employment effects of the reform operate primarily through a reduced rate of new hires for workers with a higher minimum wage, with no effect on job destructions. Consistent with the predictions of the jobs ladder model, the group subject to the higher wage is less likely to transition to another job, or seek employment while on the job.






Published or Forthcoming Papers

Income Changes and Consumption: Evidence from the 2013 Federal Government Shutdown

Review of Economic Dynamics, 23(1), 99-124, January 2017

Coauthor: Scott Baker

Media Coverage:      

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[Paper]

We use the 2013 federal government shutdown and a rich data set from an online personal finance website to study the effects of changes in income on changes in consumption. The 2013 shutdown was a significant and unanticipated income shock for federal government workers, with no direct effect on permanent income. We exploit both the differences between unaffected state employees and affected federal employees as well as between federal employees required to remain at work and those required to stay at home to generate variation in income and leisure time. We find strong evidence for excess sensitivity of consumption patterns, violating the permanent income hypothesis. The decline in spending can be largely explained by increased home production, changes in spending allocations, and credit constraints. We are able to discern detailed categories of household spending with widely varying elasticities. The results demonstrate the importance of household liquidity, leisure and home production when constructing stimulus or social insurance policy.

Quantifying the Premium Externality of the Uninsured

Journal of the European Economic Association, 14(2), 405-37, April 2016

Coauthor: Stephen Sun

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[Paper]

In insurance markets, the uninsured can generate a negative externality on the insured, leading insurance companies to charge higher premia. Using a novel panel data set and a staggered policy change that introduces exogenous variation in the rate of uninsured drivers at the county level in California, we find that uninsured drivers lead to higher insurance premia: a 1 percentage point increase in the rate of uninsured drivers raises premia by roughly 1%. We calculate the monetary fine on the uninsured that would fully internalize the externality and conclude that actual fines in most US states are inefficiently low.

Credit Constraints and Demand for Higher Education: Evidence from Financial Deregulation

Review of Economics and Statistics, 98(1), 12-24, March 2016

Coauthor: Stephen Sun

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[Paper]

This paper uses staggered bank branching deregulation across states in the United States to examine the impact of the resulting increase in the supply of credit on college enrollment from the 70s to early 90s. A significant advantage of our research design is that it produces estimates that are not confounded by wealth effects. We find that lifting branching restrictions raises college enrollment by about 2 percentage points (4%). Our results rule out alternative interpretations to the credit constraints channel. First, the effects are largest for low and middle income families, while insignificant for upper income families as well as bankrupt families who would have been unaffected by the increased access to private credit. Second, the effect of lifting branching restrictions subsided immediately following periods of increased loan limit through government student loan programs. We also show that household educational borrowing increased as a result of lifting branching restrictions. Our results provide novel evidence that credit constraints play an important role in determining household college enrollment decisions in the United States.

A Crisis in Student Loans? How Changes in the Characteristics of Borrowers and in the Institutions they Attended Contributed to Rising Loan Defaults

Brookings Papers on Economic Activity, 2015(2), 1-89, 2015

Coauthors: Adam Looney

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[Paper]

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This paper examines the rise in student loan delinquency and default drawing on a unique set of administrative data on federal student borrowing, matched to earnings records from de-identified tax records. Most of the increase in default is associated with the rise in the number of borrowers at for-profit schools and, to a lesser extent, 2-year institutions and certain other non-selective institutions, whose students historically composed only a small share of borrowers. These non-traditional borrowers were drawn from lower income families, attended institutions with relatively weak educational outcomes, and experienced poor labor market outcomes after leaving school. In contrast, default rates among borrowers attending most 4-year public and non-profit private institutions and graduate borrowers—borrowers who represent the vast majority of the federal loan portfolio—have remained low, despite the severe recession and their relatively high loan balances. Their higher earnings, low rates of unemployment, and greater family resources appear to have enabled them to avoid adverse loan outcomes even during times of hardship. Decomposition analysis indicates that changes in characteristics of borrowers and the institutions they attended are associated with much of the doubling in default rates between 2000 and 2011. Changes in the type of schools attended, debt burdens, and labor market outcomes of non-traditional borrowers at for-profit and 2-year colleges explain the largest share.

Indiscriminate Discrimination: A Correspondence Test for Ethnic Homophily in the Chicago Labor Market

Labour Economics, 19(6), December 2012

Coauthors: Nicolas Jacquemet

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[Paper]

Media Coverage:     



Numerous field experiments have demonstrated the existence of discrimination in labor markets against specific minority groups. This paper uses a correspondence test to determine whether this discrimination is due to prejudice against specific groups, or a general preference for the majority group. Three groups of identical fabricated resumes are sent to help-wanted advertisements in Chicago newspapers: one with Anglo-Saxon names, one with African-American names, and one with fictitious foreign names whose ethnic origin is unidentifiable to most Americans. Resumes with Anglo-Saxon names generate nearly one third more call-backs than identical resumes with non Anglo-Saxon ones, either African-American or Foreign. We take this as evidence that discriminatory behavior is part of a larger pattern of unequal treatment of any member of non-majority groups, ethnic homophily.




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