Loan Guarantees for Consumer Credit Markets

Abstract

Loan guarantees are arguably the most widely used policy intervention in credit markets, especially for consumers. This may be natural, as they have several features that, a priori, suggest that they might be particularly effective in improving allocations. However, despite this, little is actually known about the size of their effects on prices, allocations, and welfare.In this paper, we provide a quantitative assessment of loan guarantees, in the context of unsecured consumption loans. Our work is novel as it studies loan guarantees in a rich dynamic model where credit allocation is allowed to be affected by both limited commitment frictions and private information.Our findings suggest that consumer loan guarantees may be a powerful tool to alter allocations that, if carefully arranged, can improve welfare, sometimes significantly. Specifically, our key findings are that (i) under both symmetric and asymmetric information, guaranteeing small consumer loans nontrivially alters allocations, and strikingly, yields welfare improvements even after a key form of uncertainty-one's human capital level-has been realized, (ii) larger guarantees change allocations very significantly, but lower welfare, sometimes for all household-types, and (iii) substantial further gains are available when guarantees are restricted to households hit by large expenditure shocks. * We thank Larry Ausubel, Dean Corbae, Martin Gervais, Kevin Reffett, and participants in seminars at Arizona State, Georgia, Iowa, and the Consumer Credit and Bankruptcy Conference at the University of Cambridge for helpful comments and discussions. We also thank Brian Gaines and Jon Lecznar for assistance. The opinions expressed here are not necessarily those of the Federal Reserve Bank of Richmond or the Federal Reserve System.

Risk-bearing by the state: When is it good public policy?

“…The first group uses a Kaldor-Hicks welfare criterion that simply looks at the total size of the pie but not at its distribution across the population. With such a criterion, some papers predict that state guarantees can lead to an improved equilibrium (e.g., Ordover and Weiss 1981;Bernanke and Gertler 1990;Innes 1992;and Athreya, Tam, and Young 2010). However, others do not (e.g., Li 1998;Gale 1990;Williamson 1994).…”

Risk Absorption by the State: When is It Good Public Policy?

“…The first group uses a Kaldor-Hicks welfare criterion that simply looks at the total size of the pie but not at its distribution across the population. With such a criterion, some papers predict that state guarantees can lead to an improved equilibrium (e.g., Ordover and Weiss 1981;Bernanke and Gertler 1990;Innes 1992;and Athreya, Tam, and Young 2010). However, others do not (e.g., Li 1998;Gale 1991;Williamson 1994).…”