Keywords
U.S. mortgage market, Government-Sponsored Enterprise (GSE), mortgage default subsidy, equilibrium lending behaviour, bunching
Abstract
It is crucial to better understand the U.S. residential mortgage market, where the global financial crisis originated. In this paper, we develop an infinite-horizon continuous-time structural model to study the effects of the longstanding and widespread Government-Sponsored Enterprises (GSEs) mortgage default insurance subsidy on U.S. mortgage underwriters’ equilibrium lending behaviour. Despite the richness of the model, we obtain analytical solutions for the equilibrium loan size and interest rate. We then employ truncated loan-level data to estimate the subsidy’s magnitude using maximum likelihood by exploiting a distinctive data feature that many borrowers bunch at the subsidy eligibility cutoff. We find that the subsidy is about 25 basis points per dollar, reduces the equilibrium mortgage interest rate by the same amount (3.6% of the average rate), and increases the loan size by $15,026 (10.4% of the average size). Our modelling framework and the structural estimation of this critical parameter, the size of the GSE subsidy, enable further studies to enhance understanding of the complex U.S. housing finance system and its significant implications for financial stability both domestically and globally.
Acknowledgments
The paper is based on Chapter 2 of Zhao’s PhD dissertation at NYU in May 2016 and was completed prior to his IMF employment. Zhao is deeply indebted to his dissertation committee members Viral Acharya, Hunt Allcott, Tim Christensen, Kris Gerardi, William Greene, and Ennio Stachetti. The authors are also extremely grateful to the Editor and two anonymous referees for their helpful comments, and for the helpful discussions with Simon Anderson, Deepal Basak, Stephan Bonhomme, Jaroslav Borovicka, Joyee Deb, Michael Dickstein, Pierre Dubios, Chris Flinn, Alfred Galichon, Dan Greenwald, Hide Ichimura, Vijay Krishna, Thomas Holmes, Sam Kruger, Alessandro Lizzeri, Federico Mandelman, Konrad Menzel, Alex Murray, Montiel Olea, Fabien Postel-Vinay, Elena Stancanelli, Bruno Strulovici, Chris Taber, and Ed Vytlacil. The views expressed herein are those of the authors and should not be attributed to the IMF, its Executive Board, or its management.
Funding
The research received no funds.
Declaration of Conflicting Interests
The author declared no potential conflicts of interest with respect to the research, authorship, and publication of the article.
Declaration About the Scope of AI Utilisation
The authors did not use an AI tool in the preparation of the article.
Recommended Citation
Shi, B., & Zhao, Y. (2024). Government Subsidy in the U.S. Mortgage Market: A Structural Analysis with Bunching. Journal of Banking and Financial Economics, 2024(2), 82-106. https://doi.org/10.7172/2353-6845.jbfe.2024.2.6
First Page
82
Last Page
106
Page Count
25
Received Date
06.06.2024
Revised Date
25.11.2024
Accept Date
10.12.2024
Online Available Date
30.12.2024
DOI
10.7172/2353-6845.jbfe.2024.2.6
JEL Code
G21; G28; R31; C58; E44
Publisher
University of Warsaw