Welfare Implications of the Transition to High Household Debt

Abstract

Aggressive deregulation of the mortgage market in the early 1980s triggered innovations that greatly reduced the required home equity of U.S. households. This allowed households to cash-out a large part of accumulated equity, which equaled 71 percent of GDP in 1982. A borrowing surge followed: Household debt increased from 43 to 62 percent of GDP in the 1982-2000 period. What are the welfare implications of such a reform for borrowers and savers? This paper uses a calibrated general equilibrium model of lending from the wealthy to the middle class to evaluate these effects quantitatively.

Keywords: Financial Reform, Mortgage Debt, Interest Rates

JEL Classification: E44, E65