Phasing out the GSEs

Vadim Elenev, Tim Landvoigt and Stijn Van Nieuwerburgh

Journal of Monetary Economics, 2016, vol. 81, issue C, 111-132

Abstract: We develop a new model of the mortgage market that emphasizes the role of the financial sector and the government. Risk tolerant savers act as intermediaries between risk averse depositors and impatient borrowers. Both borrowers and intermediaries can default. The government provides both mortgage guarantees and deposit insurance. Underpriced government mortgage guarantees lead to more and riskier mortgage originations and higher financial sector leverage. Mortgage crises occasionally turn into financial crises and government bailouts due to the fragility of the intermediaries’ balance sheets. Foreclosure crises beget fiscal uncertainty, further disrupting the optimal allocation of risk in the economy. 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 and less fiscal uncertainty, consumption smoothing improves and foreclosure rates fall. 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: Financial intermediation; Housing policy; Government bailouts (search for similar items in EconPapers)
Date: 2016
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Citations: View citations in EconPapers (34)

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Working Paper: Phasing Out the GSEs (2015)
Working Paper: Phasing out the GSEs (2015)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:moneco:v:81:y:2016:i:c:p:111-132

DOI: 10.1016/j.jmoneco.2016.06.003

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