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Helicopter money or a risk sharing approach?

De Koning, Kees (2016): Helicopter money or a risk sharing approach?

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Abstract

The U.S. financial crisis of 2007-2008 clearly illustrated that some mortgage borrowings became not only a curse for investors, but equally for individual households with a mortgage and for all homeowners; for the employed who lost their jobs, for pension funds and last but not least for the U.S. government which saw its debt levels skyrocket.

Money invested in U.S. mortgage-backed securities came from around the world and this resulted in a crisis in the U.S. becoming an international financial pandemic.

Why did the crisis occur, how did it happen and what could have been done to avoid it happening?

The prevailing wisdom in the years 1997-2007 was that house prices in the U.S. were the result of supply and demand factors and therefore should not be subject of government intervention. The 2007-2008 financial crisis disabused the world of that notion in a dramatic fashion.

The main driver of the crisis was the use of borrowed funds to acquire homes. Buyers’ (and bankers’ funding) sentiment was to buy in the expectation that the rise in house prices would compensate for the interest costs. The prevailing interest matted less than the potential gains.

Table 1 in the paper shows how fast both the outstanding mortgage level and the annual increase in household real estate values grew over the period 1997-2005.

What was overlooked, however, was what the economy could bear in terms of borrowed funds as compared to its National Income (or its near equivalent of GDP).

A dynamic yet stable debt-to-income level offers the best prospects for economic growth, not just in one year, but also in the long run.

No effective action was taken to stop the excessive mortgage lending growth over the period 1997-2006; no effective action was taken to stop the deterioration in the quality of mortgage products on offer, especially from 2004 onwards; no effective action was taken to stop or diminish the risks from the securitization and internationalization of mortgages.

In the paper a number possible policy options will be explored: a “traffic light system, a “mortgage quality control system” dealing with subprime mortgages and their securitization and a “lender of last resort for individual households” option.

The suggestion is that some “helicopter money” is used in the lender of last resort option. The risk sharing approach is an option when banks individually do not follow what is required in macro-economic terms.

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