Deposit rate ceiling deregulation and mortgage innovation

Abstract

In many countries household financing of housing purchases has assumed a special role and as a consequence constraints have been imposed on financial institutions and on financing contracts. In addition, of course, direct subsidization of housing is pervasive. In a macroeconomic environment with inflation and variable interest rates, the constraints sometimes lead to problems for lenders and borrowers. In the U.S. these problems have resulted in pressures to change the nature of the lending institution, the financial intermediation structure and/or the mortgage contract. This paper considers the use of new, innovative, mortgage contract designs as a method of portfolio diversification when thrift institutions face deposit-rate ceiling deregulation. Since thrift institutions have been more constrained than commercial banks, changing the constraints on the former may lead to behavioral changes by the latter. Alternative scenarios about commercial bank deposit rate behavior are examined. It is found that contracts exist that minimize savings reallocation toward commercial banks, thus protecting, in a sense, the specialized mortgage lending institutions (thrift institutions). These contracts also have nice properties for mortgagors during inflationary periods. However, it is also found that certain new mortgage contracts may protect thrift institutions without maintaining the historical flow of capital into the housing sector.