Financial Barriers, Regulations and Innovations in Mortgage Markets
- Publication Type:
- Thesis
- Issue Date:
- 2023
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Financial barriers are at the heart of the challenges faced in mortgage markets. Efforts to alleviate financial barriers are crucial for fostering inclusive access to mortgage markets. This thesis encompasses three studies that investigate the financial barriers experienced by various market participants and propose innovative solutions to mitigate these obstacles.
The first study focuses on creating a risk-based capital framework for Government-Sponsored Enterprises (GSEs) mandated by the Federal Housing Finance Agency by 2025. We introduce a unified framework, incorporating observed and unobserved systematic risk factors for assessing systematic risk levels. Our analysis delves into capital requirements' levels and cyclicality across three distinct models. This unified framework yields a smaller asset correlation, reduces capital requirement procyclicality, and aligns with industry expectations, resulting in GSEs' capital charges of 164 billion, significantly lower than the current requirement of 312 billion. Moreover, the study reveals exposure variations to systematic risk among lender types, recourse laws, and states, enhancing capital requirements and loan pricing strategies.
The second study explores new contracts designed to alleviate borrowers' financial constraints in accessing credit. We design two ex-ante personalized contracts based on borrowers' income expectations and risk profiles over the loan age. Compared to traditional 30-year fixed-rate mortgages and ex-post contracts, our innovations reduce illiquidity while increasing leverage. These combined effects decrease default probabilities, systematic risk, and regulatory capital, offering lenders a 10 percent increase in the return on regulatory capital or borrowers 17 basis points lower credit spreads. These contracts enhance financial system resilience and mortgage market competitiveness.
In the third study, we investigate conforming loan limits (CLL) and their relationship with house prices, considering the moderating effects of lender and borrower constraints. CLLs exhibit asymmetrical ties to house prices, staying unchanged during declines but rising with price increases. This asymmetry potentially creates a regulatory bias that affects house prices and artificially inflates them. We find a positive impact before 2017 when CLL was not adjusted downward with declining house prices. The effect varies among lenders and borrowers, with more pronounced impacts on those facing fewer constraints, such as bank lenders, borrowers in non-recourse states, and less financially constrained borrowers. We recommend a tighter alignment of CLL with house price changes and dropping existing zero-growth floors for CLL.
In summary, this thesis contributes to understanding financial barriers in the mortgage market and offers solutions to enhance financial resilience, market competitiveness, and create a more inclusive and equitable economy.
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