DP8624 Housing and the Macroeconomy: The Role of Bailout Guarantees for Government Sponsored Enterprises

Author(s): Karsten Jeske, Dirk Krueger, Kurt Mitman
Publication Date: October 2011
Keyword(s): Default Risk, Government-Sponsored Enterprises, Housing, Mortgage Market
JEL(s): E21, G11, R21
Programme Areas: International Macroeconomics, Public Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=8624

This paper evaluates the macroeconomic and distributional effects of government bailout guarantees for Government Sponsored Enterprises (such as Fannie Mae and Freddy Mac) in the mortgage market. In order to do so we construct a model with heterogeneous, infinitely lived households and competitive housing and mortgage markets. Households have the option to default on their mortgages, with the consequence of having their homes foreclosed. We model the bailout guarantee as a government provided and tax-financed mortgage interest rate subsidy. We find that eliminating this subsidy leads to substantially lower equilibrium mortgage origination and increases aggregate welfare, but has little effect on foreclosure rates and housing investment. The interest rate subsidy is a regressive policy: eliminating it benefits low-income and low-asset households who did not own homes or had small mortgages, while lowering the welfare of high-income, high-asset households.