Evidence of Government Subsidy on Mortgage Rate and Default: Revisited

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 raised mortgage interest rates for loans 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 the U.S. Congress. My strategy circumvents the endogeneity problem in conventional studies. Second, using various time-to-default models, I find that the subsidy raised the mortgage default probabilities of all conforming loans. The paper has important policy implications on financial regulation and financial stability: I caution 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 Wall Street Reform and Consumer Protection Act.