Redistribution, stimulus, and U.S. mortgage interest rates

Redistribution isn’t just about transfers of income up or down the income ladder. It can also be about transfers of value across places as well. Certain U.S. government policies can favor some areas of the country over others, or can shift money from residents of one area to others elsewhere. A new paper released by the National Bureau of Economic Research examines one such policy—the interest rates for mortgages set by the two mortgage finance giants Fannie Mae and Freddie Mac. The setting of these rates by the two government-sponsored enterprises—both now in government receivership—not only redistributes income but also acts as a form of stimulus during economic downtimes

The new paper, by economists Erik Hurst, Benjamin J. Keys, Amit Seru, and Joseph S. Vavra, all of the University of Chicago, zeroes in on the interest rate set by Fannie and Freddie for the mortgage market—a rate that doesn’t vary much at all across the country after accounting for the characteristics of borrowers. This is contrary to the economic expectation that the rate would vary, considering that the probability of the risk of defaulting varies quite a bit across the country. If an economic shock hits an area, the expectation is that the rate increases as borrowers default. But that doesn’t happen.

The authors find that variable mortgage rates based on geography are indeed the case in the private mortgage market, where Fannie and Freddie do not guarantee the mortgages before they are packaged and sold as mortgage-backed securities. It’s by setting the standards and fees they charge to guarantee loans that Fannie Mae and Freddie Mac influence mortgage rates.  So why does the rate set by the two mortgage finance giants not vary? The authors chalk it up to political constraints. They detail a few times when Fannie Mae and Freddie Mac tried to increase borrowing costs for areas with higher default risk, back in 2008 and 2012, but then stepped back from the proposals due to protests from industry groups and consumer advocacy groups.

So what’s the economic impact of this redistribution of income via the mortgage interest rate on Fannie- and Freddie-guaranteed mortgages? According to the authors’ calculations, residents in a region with a lower predicted mortgage default pay the equivalent of a one-time tax of $1,000 per household. For a household in a region with a high expected default risk, they get a one-time subsidy of about $800 per household.

In total, this transfer is about $21 billion. That’s a large number, but it’s less than the federal government spent on unemployment insurance in 2014 ($49 billion), according to the authors. But the total per household transfer of $1,800 from low-risk to high-risk regions is about the same size as the tax rebates the federal government sent out to taxpayers in the immediate wake of the 2001 and 2008 recessions to help the economy recover more quickly.

The comparison to the tax rebate checks is apt not only in terms of size but also in terms of its impact. By making sure that rates don’t go much higher during a recession, the setting of mortgage interest rates on a national scale makes it easier for households in high risk areas to borrow and sustain their consumption. It’s a form of automatic stimulus that helps households handle regional economic downturns.

As the authors point out, this paper isn’t a full analysis of the economic impact of the mortgage market or even the role of Fannie and Freddie in the market. But what it does show is that polices we don’t often consider as redistributive do, in fact, change the distribution of income.