Private Valuation and Private Information: Can Mandatory Non-Recourse Mortgage Legislation Restore a Missing Market?
Jerusalem College of Technology
Tel Aviv University - Buchmann Faculty of Law
February 26, 2012
Many US states mandate only non-recourse mortgages for dwellings, thus limiting choice and raising prices. Given the perceived benefit of such mortgages, it is a puzzling fact that no lenders currently offer them in "choice" states. We simulate a housing market with a spectrum of borrowers with privately-known income distributions, and show that under plausible conditions mandating non-recourse can remedy a market failure due to asymmetric information. Non-recourse loans provide valuable insurance to borrowers by protecting assets in worst-case outcomes involving loss of both equity and income. But markets in these mortgages may be missing due to a combination of adverse selection (inability to screen out high-risk borrowers) and adverse incentives (higher prices incentivize additional walk-aways), leading to a "death spiral" of rising rates and shrinking pools. Mandating non-recourse loans obligates the lowest risk borrowers to join the pool, which in our model may increase welfare.
Number of Pages in PDF File: 31
Keywords: Mortgage, Consumer Credit, Information, Adverse Selection, death spiral, moral hazard
JEL Classification: D18, D82, E32, K12, R38working papers series
Date posted: March 27, 2012
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