Phasing out the GSEs -- Journal of Monetary Economics (July 2016)

Co-authors: Tim Landvoigt and Stijn van Nieuwerburgh

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.

Working Papers

Mortgage Credit, Aggregate Demand, and Unconventional Monetary Policy

I develop a quantitative model of the mortgage market operating in an economy with financial frictions and nominal rigidities. I use this model to study the effectiveness of large-scale asset purchases (LSAPs) by a central bank as a tool of monetary policy. When negative shocks hit, homeowner and financial sector balance sheets are impaired, borrowing constraints bind, asset prices and aggregate demand drop, hampering the transmission of conventional monetary policy. LSAPs boost aggregate demand in a crisis by directing additional lending to homeowners, raising house prices, and establishing expectations of future financial stability. However, subsequent policy normalization requires the financial sector to absorb heightened levels of borrower debt, depressing output and consumption in recovery. In the long run, a commitment to ongoing use of LSAPs in crises reduces credit and business cycle volatility and redistributes resources from borrowers and intermediaries to savers.

A Macroeconomic Model with Financially Constrained Producers and Intermediaries - Revise and Resubmit at Econometrica

Co-authors: Tim Landvoigt and Stijn van Nieuwerburgh

We propose a model that can simultaneously capture the sharp and persistent drop in macro-economic aggregates and the sharp change in credit spreads observed in the U.S. during the Great Recession. We use the model to evaluate the quantitative effects of macro-prudential policy. The model features borrower-entrepreneurs who produce output financed with long-term debt issued by financial intermediaries and their own equity. Intermediaries fund these loans combining deposits and their own equity. Savers provide funding to banks and to the government. Both entrepreneurs and intermediaries make optimal default decisions. The government issues debt to finance budget deficits and to pay for bank bailouts. Intermediaries are subject to a regulatory capital constraint. Financial recessions, triggered by low aggregate and dispersed idiosyncratic productivity shocks result in financial crises with elevated loan defaults and occasional intermediary insolvencies. Output, balance sheet, and price reactions are substantially more severe and persistent than in non-financial recession. Policies that limit intermediary leverage redistribute wealth from producers to intermediaries and savers. The benefits of lower intermediary leverage for financial and macro-economic stability are offset by the costs from more constrained firms who produce less output.