Deregulation, Competition and the Race to the Bottom

We exploit the OCC's preemption of national banks from state laws against predatory lending as a quasi-experiment to study the effect of deregulation and its interaction with competition on the supply of complex mortgages (interest-only, negative amortization, and teaser mortgages). Following the preemption ruling, national banks significantly increased their origination of loans with prepayment penalties and negative amortization features by comparison with lenders not regulated by OCC and lenders in states without predatory lending laws. Further, we highlight a competition channel: in counties where OCC-regulated lenders had larger market shares prior to the preemption, even non-OCC lenders responded by increasing their use of these riskier terms to the extent permitted by the state predatory-lending laws. Overall, our evidence suggests that the deregulation of credit markets triggered a "race to the bottom" among distressed financial institutions, working through competition between lenders.