Going for Broke: Bank Reputation and the Performance of Opaque Securities

Abstract

Can banks’ reputational concerns improve the quality of opaque, off-balance sheet securities, such as mortgage-backed securities? We study this question in a uniquely parsimonious setting. In the 1760s, Dutch banking partnerships securitized West-Indian plantation mortgages that were risky and opaque. High-reputation banks originated better mortgages and issued securities that, on average, retained 17.5% more of their value during a market collapse. Reputational effects are attenuated when the managing partners were married into wealth or received a large share of profits in the short term, suggesting that bank reputation only works if bankers are personally exposed to (long-run) reputational losses.