Business Matters

Mason research pinpoints another factor in Great Recession bank failures

Bank failures attributed to the Great Recession had several root causes. But a George Mason University study by Jerry Hanweck and Anthony Sanders, professors of finance in the School of Business, points to a previously underreported component: declining home values.

Their study, “Residential House Prices, Commercial Real Estate and Bank Failures,” which they wrote with Gary Fissel, a senior economist at the Federal Deposit Insurance Corporation (FDIC), looked at the performance of 7,000 banks from 2004 through 2015.

They concluded that while risky commercial construction loans were significant factors in bank failures through 2011, regional declines in residential home values—as much as 40 percent in parts of the Southwest and Florida, Hanweck said—were the major factor in bank failures thereafter.

“Values were tumbling,” said Hanweck, who was an economist in the Division of Research and Statistics at the Board of Governors of the Federal Reserve System. “People were becoming risk averse because they couldn’t sell their homes. They couldn’t move. They couldn’t do anything.”

The result?

“People cut back on their spending, so they weren’t taking out other kinds of loans,” Hanweck said. “They weren’t buying automobiles, and all the less risky credit the banks could have made, they weren’t making.”

Richard Klimoski, associate dean for faculty research in the School of Business, called the research “a major contribution” to the scholarship about the Great Recession.

“Not only does it help to improve our financial market theories and models, but it can also contribute to and inform policy discussions associated with preventing such a dramatic reversal of national economic conditions from regularly occurring,” Klimoski said.

Thanks to government regulations, bank loan portfolios must be more diversified and not hold as much risk in commercial real estate, Hanweck said. That, however, does not change the effect that declining home values, under any circumstance, can have on the economy.

“The contribution of our study is really that these residential real estate prices were a substantial contributor to bank failures,” Hanweck said. “Other people have found what we found about commercial real estate. But if the value of residential properties reacts the same way in the next recession, we’re going to see more bank failures than we thought we otherwise would see.”