Regional Redistribution Through the U.S. Mortgage Market

Abstract

Regional shocks are an important feature of the U.S. economy. Households' ability to self-insure against these shocks depends on how they affect local interest rates. In the U.S., most borrowing occurs through the mortgage market and is influenced by the presence of government-sponsored enterprises (GSEs). We establish that despite large regional variation in predictable default risk, GSE mortgage rates for otherwise identical loans do not vary spatially. In contrast, the private market does set interest rates which vary with local risk, and we postulate that the lack of regional variation in GSE mortgage rates is likely driven by political pressure. We use a spatial model of collateralized borrowing to show that the national interest rate policy substantially affects welfare by redistributing resources across regions. * First draft: April 2014. We thank Sumit Agarwal, Heitor Almeida, Tom Davidoff, John Driscoll, Matthew Kahn, Arvind Krishnamurthy, John Leahy, Tomasz Piskorski, Stijn Van Nieuwerburgh, Monika Piazzesi, David Scharfstein, Johannes Stroebel, Adi Sunderam, Francesco Trebbi, and seminar participants at Berkeley Haas, Ennaudi Institute, Federal Reserve Board, HEC, Indian School of Business, Kellogg, MIT, National University of Singapore, NBER Monetary Economics Program Meeting, Ohio State, Rutgers, Stanford, Toronto, UBC, UCLA, University of Chicago Booth, University of Chicago Harris, University of Illinois, University of Michigan, Wharton, the FRIC 2014 conference on financial frictions, and the NBER conference on Financing Housing Capital for helpful comments and suggestions. Any remaining errors are our own. E-mail: Erik.Hurst@chicagobooth.edu; benkeys@uchicago.edu; Amit.Seru@chicagobooth.edu; Joseph.Vavra@chicagobooth.edu. I IntroductionThe Great Recession has led to wide disparities in economic activity across regions within the United States. The extent to which households can borrow to self-insure against these regional shocks depends crucially on the interest rate and how it varies with regional economic conditions. While theoretical models typically assume that regions within a monetary union share a common interest rate 1 , a recent empirical literature provides some evidence that this assumption may be violated. 2In this paper, we systematically assess the extent to which interest rates vary with local default risk in the U.S.mortgage market, which makes up the bulk of household borrowing. We document two new facts. First, despite large regional variation in predictable default risk, there is no spatial variation in mortgage rates which are securitized by government-sponsored enterprises (GSEs). GSEs securitize most of the loans in the U.S. mortgage market, which implies that the majority of borrowers face an interest rate which does not depend on their location. Second, this lack of risk-based pricing does not occur because this risk cannot be observed ex-ante: we show that otherwise similar non-GSE loans which are securitized in the private market increase (decrease) mortgage rat...

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