Mortgage Stress Without Government Guarantees. Lessons From Hurricanes and the Credit Risk Transfers

We use the new market for Credit Risk Transfers (CRTs) and the landfall of two major hurricanes to study both how markets price default risk from natural disasters, and how U.S. mortgage rates would change in absence of government-backed guarantees. First, we exploit that CRTs differ in the geographical and loan-to-value composition of their reference pool and in subordination. Thus, CRTs differ in exposure to the risk of mortgage defaults caused by the hurricanes. We estimate that for the riskiest CRTs the hurricanes increased spreads by 10% of the average spreads before the landfall. Second, we calibrate a model of credit supply to match the previous estimates. We use the model to estimate how changes in default probabilities change the market price of mortgage credit. For example, during the Global Financial Crisis mortgage rates would have increased by 29% absent government guarantees and monetary policy interventions