This paper analyzes a model of the mortgage market, considering scenarios with and without government-sponsored mortgage securitization. Conventional wisdom says that securitization, by fostering diversification and creating a “safe” asset in the form of mortgage-backed security (MBS), will reduce risk and enhance liquidity, thereby mitigating financial crises. We construct a strategic-game framework to model the interaction between the securitizer and banks. In this framework, the securitizer initiates the process by setting the MBS contract terms, which includes the guaranteed rate and the criterion that qualifies a mortgage for securitization. The bank then selects which qualifying mortgages to exchange for the MBS. Our investigation leads to a key result: government-sponsored securitization, somewhat counterintuitively, is more likely to exacerbate the severity and frequency of financial crises.

Financial institutions that are "Too-Big-to-Fail" impede proper market functioning in financial services. These firms can undermine the disciplining effects of capital markets should their failure have substantial "knock-on" effects on the real economy.

The government-sponsored enterprises (GSEs), Fannie Mae and Freddie Mac, play a foundational role in U.S. housing finance. This chapter gives the reader an introduction to the GSEs by reviewing their Charters and Special Status and by surveying research on how the GSEs impact the U.S. mortgage markets. The chapter also summarizes the history of the GSEs, including their fall into conservatorship, as well as the major issues involved in GSE reform efforts. Throughout, the chapter identifies many opportunities for further research, including those related to the political economy of the U.S. housing finance system, the government's attempt to internalize externalities in housing finance, the potential for racial bias in mortgage lending, the impact of the GSEs on housing supply generally and multifamily housing specifically, the role of fintech at the GSEs, the impact of firms being too big to fail, and the relationship between GSE MBS and the shadow money supply.

We construct a model of a bank’s optimal funding choice, where the bank negotiates with both safety-driven short-term bondholders and (mostly) risk-taking long-term bondholders. We establish that investor demands for safety create a negative relationship between the bank’s capital choices and short-term funding, as well as negative relationships between capital and common measures of bank liquidity. Short-term investors’ demands for safety force the bank to hold more collateral, which diminishes the demands by long-term bondholders for higher holdings of bank capital. Consistent with our model, our bank-level empirical analysis of these capital–liquidity trade-offs shows that bank liquidity measures have a strong and negative relationship to the capital ratio. Furthermore, we show that this trade-off does not appear to be regulation related and has diminished in size over time.

As developed by the BCBS, the expected impact framework is the theoretical foundation for calibrating the capital surcharge applied to global systemically important banks (G-SIB surcharge). This paper describes four improvements to the current implementation of the BCBS expected impact framework. We (i) introduce a theoretically sound and an empirically grounded approach to estimating a probability of default (PD) function; (ii) apply density-based cluster analysis to identify the reference bank for each G-SIB indicator; (iii) recalibrate the systemic loss-given-default (LGD) function that determines G-SIB scores, using both the current system based on supervisory judgment and using an alternative system based on CoVaR; and (iv) derive a continuous capital surcharge function to determine G-SIB capital surcharges. Our approach would strengthen the empirical and theoretical foundation of the G-SIB surcharge framework. Moreover, the continuous surcharge function would reduce banks' incentive to manage their balance sheets to reduce systemic capital surcharges, mitigate cliff effects, allow for the lifting of the cap on the substitutability score and penalise growth in the category for all G-SIBs. In addition, our two capital surcharge functions might be used to monitor G-SIBs' capital adequacy and distortions induced by G-SIB surcharges.

Did government mortgage programs mitigate the adverse economic effects of the financial crisis? We find that counties with greater participation in traditional government mortgage programs experienced less severe economic downturns during the Great Recession. In particular, counties with higher levels of participation in FHA, Fannie Mae, and Freddie Mac lending had relatively smaller increases in mortgage delinquency rates; smaller declines in purchase originations, home sales, home prices, and new automobile purchases; and smaller increases in unemployment rates. These results hold both in 2009 (soon after the peak of the financial crisis) and in 2014 (six years after the crisis). The persistence of better economic outcomes in these counties is consistent with a view that mortgage originators' access to a liquidity outlet (in this case, government-backed securitization) is key to maintaining credit flows and economic growth during financial turmoil.

We construct a model of a bank's optimal funding choice, where the bank negotiates with both safety-driven short-term bondholders and (mostly) risk-taking long-term bondholders. We establish that investor demands for safety create a negative relationship between the bank's capital choices and short-term funding, as well as negative relationships between capital and common measures of bank liquidity. Consistent with our model, our bank-level empirical analysis of these capital-liquidity tradeoffs show (1) that bank liquidity measures have a strong and negative relationship to its capital ratio for both large and small banks, and (2) that this relationship has weakened with the advent of stronger liquidity regulation. Our results suggest that the safety concerns of bank debt investors may underlie capital-liquidity tradeoffs and that a bank's share of collateralized short-term debt may be a more robust measure of bank liquidity.

A safe asset is a debt instrument that is expected to maintain its value over time, especially during adverse systemic events. Changes in the supply of safe assets can have a significant influence on short-term, risk-free interest rates. (Ferreira & Shousha, 2020) "When the scarcity of safe asset[s] is acute, the zero lower bound (ZLB) becomes binding and the safe asset market equilibrates via a reduction in output…"

The 30-year fixed-rate fully amortizing mortgage (or "traditional fixed-rate mortgage") was a substantial innovation when first developed during the Great Depression; however, it has three major flaws. First, homeowner equity accumulates slowly during the first decade. Many lenders require large down payments because of slow equity accumulation. Second, in each monthly mortgage payment, homeowners substantially compensate capital markets investors for the ability to prepay. The homeowners might have better uses for this money. Third, refinancing mortgages is often very costly. Expensive refinancing may prevent homeowners from taking advantage of falling rates. To resolve these three flaws, we propose a new fixed-rate mortgage, called the Fixed-Payment-COFI mortgage (or "Fixed-COFI mortgage"). This mortgage has fixed monthly payments equal to payments for traditional fixed-rate mortgages and does not require a down payment. Also, unlike traditional fixed-rate mortgages, Fixed-COFI mortgages do not bundle mortgage financing with compensation paid to capital markets investors for bearing prepayment risks; instead, this money is directed toward lower monthly payments or toward purchasing the home. The Fixed-COFI mortgage exploits the often-present prepayment-risk "wedges" between the fixed-rate mortgage rate and the estimated cost of funds index (COFI) mortgage rate. In addition, the Fixed-COFI mortgage is a highly profitable asset for many mortgage lenders. We discuss two variations of the Fixed-COFI mortgage. In the first variation, homeowners with "Affordable" Fixed-COFI mortgages are rebated the "wedges" between the traditional fixed-rate mortgage payments and the COFI mortgage payments. After the "wedges" are rebated, these homeowners may pay substantially less to purchase their homes in 30 years than homeowners with traditional fixed-rate mortgages. This mortgage design may help alleviate housing affordability pressures in many areas of the United States. The other variation of Fixed-COFI mortgage is the "Homeownership" Fixed-COFI mortgage. With the "homeownership" Fixed-COFI mortgage, the homeowner commits to a savings program based on the difference between fixed-rate mortgage payments and payments based on COFI plus a margin. The homeowner uses this "wedge" to accumulate home equity quickly. The Homeownership Fixed-COFI mortgage may help some renters gain access to homeownership. For example, these renters may be paying rents as high as comparable mortgage payments in high-cost metropolitan areas but may not have enough savings for a down payment. With less need for a down payment, the Fixed-COFI mortgage may help such renters with stable income-but no savings-purchase homes.

The Basel Committee promulgates bank regulatory standards that many major economies enact to a significant extent. One element of the Basel III capital standards is a system of capital surcharges for global systemically important banks (G-SIBs). If the purpose of the surcharges is to ensure the survival of G-SIBs through serious crises (like the 2007-09 financial crisis) without extraordinary public assistance, our analysis suggests that current surcharges are too low because of three shortcomings: (1) the Basel system underestimates the probability that a G-SIB can fail, (2) the Basel system fails to account for short-term funding, and (3) the Basel system excludes too many banks from current surcharges. Our best estimate suggests that the current surcharges should be between 225 and 525 basis points higher for G-SIBs that are not reliant on short-term funding; G-SIBs that are reliant on short-term funding should have even higher surcharges. Furthermore, we find that, even with significant confidence in the effectiveness of other Basel III reforms, modest increases in surcharges appear needed.

Before 2008, the government?s ?implicit guarantee? of the securities issued by the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac led to practices by these institutions that threatened financial stability. In 2008, the Federal Housing Finance Agency placed these GSEs into conservatorship. Conservatorship was intended to be temporary but has now reached its tenth year, and policymakers continue to weigh options for reform. In this article, the authors assess both implicit and explicit government guarantees for the GSEs. They argue that adopting a legislatively defined ?explicit guarantee,? as advocated by some, may be problematic for a variety of reasons, including the difficulty of pricing such a guarantee and the potential high cost for mortgage holders or the government. In addition to the creation of an explicit guarantee, they recommend that steps be taken to limit systemic risk in housing markets. To that end, they advocate the wider adoption of mortgages?such as the ?Fixed-COFI? mortgage?that build homeowner equity faster than the thirty-year fixed-rate mortgage favored by the GSEs. With such mortgages, homeowners are better able to weather economic downturns.

The authors examine the connection between government mortgage programs and economic outcomes during and after the financial crisis. They find a strong correlation between counties that participated more heavily in Federal Housing Administration (FHA)/Veterans Affairs (VA) and government-sponsored enterprise (GSE) mortgage lending before the crisis and better economic outcomes during and after the crisis. Although the financial crisis was a substantial shock to all counties, those more reliant on FHA/VA or GSE lending experienced smaller increases in unemployment rates; smaller declines in new automobile purchases, home prices, home sales, and mortgage purchase originations; and smaller increases in mortgage delinquency rates. Moreover, the authors find that the FHA was a more effective countercyclical tool during and after the 2007-09 financial crisis than the GSEs. This finding may have implications for GSE reform: Greater access to government backing during crises may mitigate tighter underwriting standards and rising securitization costs in mortgage markets.

The authors examine the connection between government mortgage programs and economic outcomes during and after the financial crisis. They find a strong correlation between counties that participated more heavily in Federal Housing Administration (FHA)/Veterans Affairs (VA) and government-sponsored enterprise (GSE) mortgage lending before the crisis and better economic outcomes during and after the crisis. Although the financial crisis was a substantial shock to all counties, those more reliant on FHA/VA or GSE lending experienced smaller increases in unemployment rates; smaller declines in new automobile purchases, home prices, home sales, and mortgage purchase originations; and smaller increases in mortgage delinquency rates. Moreover, the authors find that the FHA was a more effective countercyclical tool during and after the 2007-09 financial crisis than the GSEs. This finding may have implications for GSE reform: Greater access to government backing during crises may mitigate tighter underwriting standards and rising securitization costs in mortgage markets.

The 30-year fixed-rate fully amortizing mortgage (or "traditional fixed-rate mortgage") was a substantial innovation when first developed during the Great Depression. However, it has three major flaws. First, because homeowner equity accumulates slowly during the first decade, homeowners are essentially renting their homes from lenders. With so little equity accumulation, many lenders require large down payments. Second, in each monthly mortgage payment, homeowners substantially compensate capital markets investors for the ability to prepay. The homeowner might have better uses for this money. Third, refinancing mortgages is often very costly. We propose a new fixed-rate mortgage, called the Fixed-Payment-COFI mortgage (or "Fixed-COFI mortgage"), that resolves these three flaws. This mortgage has fixed monthly payments equal to payments for traditional fixed-rate mortgages and no down payment. Also, unlike traditional fixed-rate mortgages, Fixed-COFI mortgages do not bundle mortgage financing with compensation paid to capital markets investors for bearing prepayment risks; instead, this money is directed toward purchasing the home. The Fixed-COFI mortgage exploits the often-present prepayment-risk wedge between the fixed-rate mortgage rate and the estimated cost of funds index (COFI) mortgage rate. Committing to a savings program based on the difference between fixed-rate mortgage payments and payments based on COFI plus a margin, the homeowner uses this wedge to accumulate home equity quickly. In addition, the Fixed-COFI mortgage is a highly profitable asset for many mortgage lenders. Fixed-COFI mortgages may help some renters gain access to homeownership. These renters may be, for example, paying rents as high as comparable mortgage payments in high-cost metropolitan areas but do not have enough savings for a down payment. The Fixed-COFI mortgage may help such renters, among others, purchase homes.

The Basel Committee on Banking Supervision (BCBS, the Basel Committee, or Basel) has developed a methodology for identifying global systemically important banks (G-SIBs) and standards for requiring G-SIBs to hold more common equity.

The Great Recession provides an opportunity to test the proposition that government mortgage insurance programs mitigated the effects of the financial crisis and enhanced the economic recovery from 2009 to 2014. We find that government-sponsored mortgage insurance programs have been responsible for better economic outcomes in counties that participated heavily in these programs. In particular, counties with high levels of participation from government-sponsored enterprises and the Federal Housing Authority had relatively lower unemployment rates, higher home sales, higher home prices, lower mortgage delinquency rates, and less foreclosure activity, both in 2009 (soon after the peak of the financial crisis) and in 2014 (six years after the crisis) than did counties with lower levels of participation. The persistence of better outcomes in counties with heavy participation in federal government programs is consistent with a view that lower government liquidity premiums, lower government credit-risk premiums, and looser government mortgage-underwriting standards yield higher private-sector economic activity after a financial crisis.

The United Sates government has a long history of involvement in mortgage finance. During the 1930s, the government created the Federal Home Loan Banks (FHLB), the Federal Housing Administration (FHA), and the Federal National Mortgage Association (Fannie Mae). In this note, we estimate how the intensity of GSE, FHA, PLS, and portfolio exposures influence the state of the real economy across counties.

Principles of Stability, (anticipated publication date: Spring 2016). The chapters lay out a roadmap for reforms to achieve the goals of liquidity, stability, access and sustainability. They represent some of the best thinking by policy researchers and economic experts to the challenges that lie ahead for the rebuilding of this key sector of our nation’s economy. For more information visit www.upenn.edu/pennpress/series/C21.html. HOUSING FINANCE REFORM

We analyze the feasibility an adjustable-rate mortgage product tied to a nationwide bank cost of funds index (COFI) that is equal to the total interest expense divided by the total liabilities for all domestic commercial banks. This mortgage product also includes actuarial based government-backed tail-risk insurance provided either to bankers directly or to investors who purchase pools of these mortgages. We refer to a COFI mortgage with this form of catastrophic insurance as a "COFI-Cat" contract. The costs and benefits associated with these contracts are considered from the perspective of households, bankers, investors and policymakers using estimates of COFI-Cat rates constructed from historical data over 2000-2014, inclusive.For households, monthly mortgage payment cost savings for COFI-Cat mortgages compared to 30-year fixed-rate mortgages are substantial, estimated to average more than $100 per month at issuance over the period considered and to accumulate to more than $11,000 over a typical six-year period, the average tenure a household spends in a home. Thus, cost savings could be substantial for homeowners who expect rates to fall or who have a higher moving probability.For bankers, hedging costs for COFI-Cat mortgages are lower than for either 30-year fixed-rate mortgages or adjustable-rate mortgages based on short-term market-based rates. Because banking organizations have cost of funds that generally move in sync with each other, mortgage-backed securities (MBS) based on pools of COFI-Cat mortgages potentially provide much needed geographic diversification, particularly for smaller U.S. banks, while still being relatively easy to hedge compared to fixed-rate and other adjustable-rate mortgages.For investors, such as asset managers, banks, thrift institutions, pension funds and central banks, COFI-Cat MBS could provide lucrative opportunities for stable returns. Historically, we demonstrate LIBOR funded investors could have hedged such MBS and maintained positive returns even when LIBOR rates blew out in 2008. Moreover, credit risk transfer transactions structured in a manner that the government backs only catastrophic risks are shown to result in guarantee fees that are lower than those actually charged by the GSEs during 2012-2014.For policymakers, replacing fixed-rate mortgages with adjustable rate mortgages, such as COFI-Cat mortgages, could improve monetary policy pass-through when market rates are lowered; households would not need to refinance when interest rates drop, thereby benefiting a broad range of households, including those with little or no home equity and/or low credit scores. As a result, the need for special federal programs such as the Home Affordable Refinance Program or FHASecure is potentially reduced. In a rising interest rate environment, depository institution COFIs tend to adjust at a slower pace than other indexes typically tied to adjustable-rate mortgages. Consequently, the distributional consequences associated with tighter monetary policy are less with COFI-based mortgage contracts than with other adjustable-rate mortgage contracts. Published by Elsevier Inc.