Tag Archives: Mortgage

Redistribution From Unexpected Deflation in the Euro Area

In the JEEA 14(4) (August 2016) Klaus Adam and Junyi Zhu argue that

unexpected price-level movements generate sizable wealth redistribution in the Euro Area (EA) … The EA as a whole is a net loser of unexpected price-level decreases, with Italy, Greece, Portugal, and Spain losing most in per capita terms, and Belgium and Malta being net winners. Governments are net losers of deflation, while the household (HH) sector is a net winner … HHs in Belgium, Ireland, Malta, and Germany experience the biggest per capita gains, while HHs in Finland and Spain turn out to be net losers. … relatively young middle class HHs are net losers of deflation, while older and richer HHs are winners. … wealth inequality in the EA increases with unexpected deflation, although in some countries (Austria, Germany, and Malta) inequality decreases due to the presence of relatively few young borrowing HHs. … HHs in high-inflation EA countries hold… systematically lower nominal exposures.

The table reports the estimated effects of a one-time unexpected change in the general price level by 10% (expressed either in thousand EUR per capita, or as a share of GDP); a positive sign indicates a gain from deflation.

(1000 EUR p.c.)
(1000 EUR p.c.)
(1000 EUR p.c.)
(share of GDP)
(share of GDP)
(share of GDP)
Euro Area−18.67.810.8−0.730.300.42

Deposit Insurance: Economics and Politics

On VoxEU, Charles Calomiris and Matthew Jaremski discuss the origins of bank liability insurance. They argue that it is redistribution, not the aim to boost efficiency, which explains a lot of the action.

… there are two theoretical approaches to explaining the creation and expansion of deposit insurance. The first is an economic approach grounded in potential efficiency gains from limiting bank runs (i.e. the public interest motivation). The second is a political approach grounded in the rising power of special interest groups that favoured insurance as a means to access subsidies (i.e. the private interest motivation).

… Because insurance reduces the incentive for market discipline, it may increase fundamental insolvency risk … whether, on balance, bank liability insurance reduces or increases risk … is an empirical question. Economic theories of liability insurance only make sense on economic grounds if the gains from liquidity risk reduction tend to exceed the moral hazard or adverse selection costs from reduced market discipline.

… Political models seek to explain why liability insurance may be chosen to favour certain groups in society even when it imposes large costs on society in the form of higher systemic risk for banks. In this context, liability insurance needs to be understood as part of an equilibrium political bargain achieved by a winning political coalition. …

… we review empirical evidence about, first, which factors are shown to be instrumental in creating bank liability insurance; and second, evidence about the consequences of passing insurance … We find that political theories are much more consistent with both sets of evidence.

… the historical push for liability insurance in the US came from a coalition of small rural bankers and landowning farmers …

Worldwide, bank liability insurance remained a unique (and controversial) policy choice of the US until the late 1950s, but it spread rapidly throughout the world in recent decades …

Like the adoption of liability insurance in the US, the recent global wave of legislation creating and expanding insurance can also be traced to political influences. …

The expansion of liability insurance has been generally associated with reductions in banking system stability …

The political theories of liability insurance point to a major political advantage. It provides an effective means for a government to supply hard-to-trace subsidies to particular classes of bank borrowers … agricultural borrowers or urban mortgage borrowers …

Liability insurance can create a subsidy for banks (which they can pass through, in part, to borrowers) only if prudential regulation and supervision permit banks to take risks at the expense of the insurer. Thus, lax regulation and supervision are an important part of the political bargain that allows liability insurance to deliver subsidies to banks and targeted borrowers. …

Previous Cohorts’ Household Debt Was Much Lower

In a blog post, May Rostom documents that “secured debt is rising super-fast for the young.”

Over the life cycle, each generation accumulates household debt until reaching age forty or fifty, and repays afterwards. But the level of indebtedness (in real terms) has increased from cohort to cohort, and peak indebtedness has shifted to older age. The amplitude of the income paths has not changed to the same extent—“income growth has been unable to keep up with the pace of house price inflation.” Moreover, while “the younger groups have taken the lion’s share of the increase in debt from 1995-2012, … the biggest winners [when it comes to wealth accumulation] have been the older generations.”

Regulation of Fannie Mae and Freddie Mac

The Economist reports about plans to have Fannie Mae and Freddie Mac accept mortgages for intermediation and insurance even if these mortgages only satisfy weaker lending standards than those currently required by the two government sponsored entities. (Fannie Mae and Freddie Mac buy eligible mortgages, repackage and guarantee them and sell them on to investors.) The plans to accept laxer lending standards appear to be motivated by the aim to improve the affordability of home ownership for risky borrowers. The same aim is widely credited to have contributed towards sowing the seeds of the recent financial crisis.