Working Paper: CEPR ID: DP14458
Authors: Toni Ahnert; Martin Kuncl
Abstract: We study third-party loan guarantees in a model in which lenders can screen and sell loans before maturity when in need of liquidity. Loan guarantees improve market liquidity, reduce lending standards, and can have a positive overall welfare effect. Guarantees improve the average quality of non-guaranteed loans traded and thus the market liquidity of these loans due to selection. This positive pecuniary externality provides a rationale for guarantee subsidies. Our results contribute to a debate about reforming government-sponsored mortgage guarantees by Fannie Mae and Freddie Mac, suggesting that the excessively high subsidies to these guarantees should be reduced but not completely eliminated.
Keywords: mortgage guarantees; adverse selection; market liquidity; pecuniary externality; Pigouvian subsidy; government sponsored enterprises
JEL Codes: G01; G21; G28
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| loan guarantees (H81) | market liquidity (G10) |
| loan guarantees (H81) | average quality of non-guaranteed loans traded (G33) |
| average quality of non-guaranteed loans traded (G33) | market liquidity (G10) |
| loan guarantees (H81) | lending standards (G21) |
| lending standards (G21) | overall quality of loans in the market (G21) |
| loan guarantees (H81) | overall welfare effects (D69) |