This project consists of several papers
Risky Mortgages in DSGE Model
This project develops a model with housing and risky mortgages. The returns to housing are subject to aggregate and idiosyncratic risk; underwater mortgages – when the balance on the mortgage is higher than the market value of the house — are defaulted in equilibrium. We capture the rise in subprime lending with an increase in the idiosyncratic riskiness of mortgages. An increase in mortgage risk raises default and generates a credit crunch and a recession. Highly leveraged economies suffer deeper recessions: borrowers are more likely to experience negative equity in their housing, so the rate of default increases, thereby forcing further deleveraging. Monetary policy plays an important role in the transmission of a housing risk shock, as more inertial interest rate rules generate deeper output contractions.
Published Version: Riskiy Mortgage in a DSGE Model; by Luisa Lambertini and Chiara Forlati
Working Paper: Risky Mortgages in a DSGE Model;
Alternative mortgage contracts
The U.S. housing market boom was in part fueled by government housing policies aimed at expanding credit to low-income households. Such credit expansion was made possible by the introduction of non-standard mortgage products characterized by low down payments and reduced (initial) repayments. This paper builds a dynamic stochastic general equilibrium model with housing and endogenous default on mortgages to study the welfare effects of alternative mortgage contracts. We find that non-standard mortgage contracts with low down payments and reduced amortization make credit-constrained borrowers worse off and unconstrained households (savers) better off at least in the long run. Our results can be explained only in the light of general equilibrium effects. When offered mortgages with low amortization rates, credit-constrained agents rationally choose to take advantage of them and borrow more because they take prices as given. But higher housing demand raises housing prices. To afford housing at the higher prices, borrowers cut non-durable consumption and work more, thereby reducing their welfare. Our results contribute to the recent policy debate on the reform of the mortgage market.
Working Paper: Mortgage Amortization and Welfare; by Luisa Lambertini and Chiara Forlati
Mortgage Modification Policies in an Estimated Model
This paper uses U.S. data for the period 1981-2006 to estimate a medium-size model of the economy that includes housing, mortgages and endogenous default. The model is estimated using Bayesian techniques. In our model two shocks are well suited to replicate the subprime crisis and the Great Recession: the mortgage risk shock and the housing demand shock. Mortgage risk shocks raise default and prompt households to deleverage and reduce consumption. Housing investment and GDP fall as well. Housing demand shocks induce substitution out of durable goods (houses) into non-durable goods (consumption). The decrease in the demand for housing generates a precipitous fall in housing investment and prices and an increase in the loan-to-value ratio. Next we use our estimated model to evaluate a policy that reduces the principal of underwater mortgages. This policy is successful in stabilizing the mortgage market and improving welfare for all agents.
Working Paper: Mortgage Default in an Estimated Model of the U.S. Housing Market ;by Luisa Lambertini, Pynar Uysal and Victoria Nuguer
Boom-bust Cycles in the Housing Market
Using a vector-autoregression (VAR) model and data from the University of Michigan Survey of Consumers, we provide evidence on the importance of news and consumers’ beliefs for housing-market dynamics and aggregate fluctuations. We document that innovations to News on Business Conditions generate hump-shaped responses in house prices and other macroeconomic variables. We also show that innovations to Expectations of Rising House Prices are particularly important in explaining the path of macroeconomic variables during housing booms. To disentangle the effects of News on Business Conditions from other sources of expectation-driven cycles, we estimate a VAR where the News variable is ordered first. Innovations to News on Business Conditions generate Expectations of Rising House Prices. However, during housing booms, innovations to Expectations of Rising House Prices unrelated to Newson Business Conditions account for a large part of macroeconomic fluctuations. Shocks to News and Expectations account together for more than half of the forecast error variance of house prices, and other macroeconomic variables, during periods of booms in house prices.
Published Version: Expectations-Driven Cycles in the Housing Market: Evidence from Survey Data
Working Paper: Expectations-Driven Cycles in the Housing Market: Evidence from Survey Data ;by Luisa Lambertini, Caterina Mendicino and Maria Teresa Punzi
Leaning Against Boom-Bust Cycles in Credit and Housing Prices
This project studies the potential gains of monetary and macro-prudential policies that lean against house-price and credit cycles. We rely on a model that features Borrowers and Savers and allows for over-borrowing induced by news-shock-driven cycles. We find that policy that responds to changes in financial variables is socially optimal. Considering the use of a single policy instrument, both types of agents are better off when the interest rate optimally respond to credit growth. When we allow for the implementation of both interest-rate and LTV policies, heterogeneity in the welfare implications is key in determining the optimal use of policy instruments. The optimal policy for the Borrowers is characterized by a LTV ratio that responds countercyclically to credit growth, which most effectively stabilizes credit relative to GDP. In contrast, the optimal policy for the Savers features a constant LTV ratio coupled with an interest-rate response to credit growth. News-shock-driven cycles account for most of the gains from a policy response to changes in financial variables.
Published Version: Leaning Against Boom-Bust Cycles in Credit and Housing Prices
Working Paper: Leaning Against Boom-Bust Cycles in Credit and Housing Prices; by Luisa Lambertini, Caterina Mendicino and Maria Teresa Punzi
Collaborators
Luisa Lambertini