Three Proposals for Regulating the Distribution of Home Equity

50 Pages Posted: 16 Oct 2012 Last revised: 27 Mar 2013

See all articles by Ian Ayres

Ian Ayres

Yale University - Yale Law School; Yale University - Yale School of Management

Joshua Mitts

Columbia Law School

Date Written: February 1, 2013


The CFPB’s recently released “qualified mortgage” rules effectively discourage predatory lending but miss an equally important source of systemic risk: low-equity clustering. Specific “volatility inducing” mortgage terms when present in a substantial cluster of mortgage contracts exacerbate macroeconomic risk by increasing the chance that the housing and lending markets will have to absorb a wave of simultaneous defaults after a downturn in housing prices. We show that these terms became prevalent in a substantial proportion of residential mortgages in the years leading up to the home mortgage crisis. In contrast, during the earlier “amortization era” (when mortgagors were more likely to borrow at different times, with more substantial down payments, and more continual rates of amortization, without a need to refinance), an equally sized negative shock to housing prices would likely produce less negative equity, to a smaller set of borrowers. Instead of prohibiting the volatility-inducing terms, we propose three policies to better assure a greater diversification in the distribution of equity: (a) a modified home-mortgage interest deduction; (b) a modified “qualified residential mortgages” standard; and most importantly, (c) direct macroprudential regulation through a “cap-and-trade” system of leverage licenses and instituting varying degrees of “conforming mortgages” for Fannie Mae and Freddie Mac. Limiting the simultaneous clustering of negative equity mortgages can reproduce the structural advantages that were a natural byproduct of the amortization era where inevitable downturns, which disparately impacted homeowners with different levels of equity, could more easily be absorbed by the market.

Keywords: mortgage, equity, distribution, regulation, Dodd-Frank, leverage, licensing

Suggested Citation

Ayres, Ian and Mitts, Joshua, Three Proposals for Regulating the Distribution of Home Equity (February 1, 2013). Yale Journal on Regulation, Forthcoming, Available at SSRN: or

Ian Ayres

Yale University - Yale Law School ( email )

P.O. Box 208215
New Haven, CT 06520-8215
United States
203-432-7101 (Phone)
203-432-2592 (Fax)

Yale University - Yale School of Management

135 Prospect Street
P.O. Box 208200
New Haven, CT 06520-8200
United States

Joshua Mitts (Contact Author)

Columbia Law School ( email )

435 West 116th Street
New York, NY 10025
United States

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