Evidence of Government Subsidy on Mortgage Rate and Default: Revisited

Abstract

I empirically evaluate the subsidized default insurance policy (implemented through the guarantee for Government-Sponsored Enterprises) in the U.S. mortgage market. First, I find that the subsidy has raised mortgage interest rates for all loans strictly eligible for the subsidy (conforming loans), which is contrary to conventional wisdom. I do so by applying regression discontinuity designs and using the exogenous variation generated by a mandate of U.S. Congress. My empirical strategy circumvents the endogeneity problem in conventional studies. Second, using various time-to-default models, I find that the subsidy has raised mortgage default probabilities of all conforming loans. My paper cautions regulators against interpreting the observed jumbo-conforming spread as an indication that the subsidy necessarily lowers mortgage rates and benefits conforming borrowers; highlights the adverse impact of the subsidy on financial stability; and calls for deeper housing finance reforms in the U.S. beyond the Dodd-Frank Act.

Keywords: U.S. Mortgage, Government-Sponsored Enterprises, Default, Regression Discontinuity Designs, Duration Models

JEL Classification: C54, G18, G21, R3