Working Paper: NBER ID: w21626
Authors: Vadim Elenev; Tim Landvoigt; Stijn Van Nieuwerburgh
Abstract: We develop a new model of the mortgage market where both borrowers and lenders can default. Risk tolerant savers act as intermediaries between risk averse depositors and impatient borrowers. The government plays a crucial role by providing both mortgage guarantees and deposit insurance. Underpriced government mortgage guarantees lead to more and riskier mortgage originations as well as to high financial sector leverage. Mortgage crises occasionally turn into financial crises and government bailouts due to the fragility of the intermediaries' balance sheets. Increasing the price of the mortgage guarantee "crowds in" the private sector, reduces financial fragility, leads to fewer but safer mortgages, lowers house prices, and raises mortgage and risk-free interest rates. Due to a more robust financial sector, consumption smoothing improves and aggregate welfare increases. While borrowers are nearly indifferent to a world with or without mortgage guarantees, savers are substantially better off. While aggregate welfare increases, so does wealth inequality.
Keywords: Mortgage market; Government guarantees; Financial stability; Wealth inequality
JEL Codes: E0; E21; E62; G00; G12; G18; G21; G28
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| government mortgage guarantees (H81) | increased mortgage originations (G21) |
| increased mortgage originations (G21) | heightened financial sector leverage (F65) |
| government mortgage guarantees (H81) | heightened financial sector leverage (F65) |
| increasing the price of mortgage guarantees (G21) | crowds in the private sector (D26) |
| crowds in the private sector (D26) | reduces financial fragility (G59) |
| increasing the price of mortgage guarantees (G21) | safer mortgages (G21) |
| abolition of government guarantees (H81) | better-capitalized financial sector (F65) |
| absence of guarantees (D52) | less risky behavior by banks (G21) |
| presence of guarantees (H81) | borrower indifference (D11) |
| reformed system (P41) | higher interest rates for savers (E43) |