Discussion paper

DP14458 Government Loan Guarantees, Market Liquidity, and Lending Standards

We study third-party loan guarantees in a model in which lenders can screen and sell loans before maturity when in need of liquidity. Loan guarantees improve market liquidity, reduce lending standards, and can have a positive overall welfare effect. Guarantees improve the average quality of non-guaranteed loans traded and thus the market liquidity of these loans due to selection. This positive pecuniary externality provides a rationale for guarantee subsidies. Our results contribute to a debate about reforming government-sponsored mortgage guarantees by Fannie Mae and Freddie Mac, suggesting that the excessively high subsidies to these guarantees should be reduced but not completely eliminated.


Ahnert, T and M Kuncl (2022), ‘DP14458 Government Loan Guarantees, Market Liquidity, and Lending Standards‘, CEPR Discussion Paper No. 14458. CEPR Press, Paris & London. https://cepr.org/publications/dp14458