The Impact of Deregulation and Financial Innovation on Consumers: The Case of the Mortgage Market

Authors

  • KRISTOPHER S. GERARDI,

  • HARVEY S. ROSEN,

  • PAUL S. WILLEN

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    • Gerardi is from the Federal Reserve Bank of Atlanta, Rosen from Princeton University and Willen from the Federal Reserve Bank of Boston. We are grateful to a referee and an associate editor, both anonymous, and Campbell Harvey, a very patient editor, for many helpful comments and suggestions. We also thank Mark Aguiar, Mark Doms, Karen Dynan, Jean Grossman, Bob King, Yolanda Kodrzycki, Wayne Passmore, Julio Rotemberg, Scott Schuh, Frank Vannerson, Mark Watson, and audiences at numerous conferences and seminars for helpful suggestions. Finally, we thank Jeff Fuhrer for providing us with computer programs. This research has been supported by Princeton's Center for Economic Policy Studies.


ABSTRACT

We develop a technique to assess the impact of changes in mortgage markets on households, exploiting an implication of the permanent income hypothesis: The higher a household's expected future income, the higher its desired consumption, ceteris paribus. With perfect credit markets, desired consumption matches actual consumption and current spending forecasts future income. Because credit market imperfections mute this effect, the extent to which house spending predicts future income measures the “imperfectness” of mortgage markets. Using micro-data, we find that since the early 1980s, mortgage markets have become less imperfect in this sense, and securitization has played an important role.

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