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Since the global financial crisis of 2008, macroprudential housing-finance tools (MPTs) have been increasingly utilized to reduce financial system vulnerabilities related to housing market imbalances. Macroprudential tools are financial policies aimed at ensuring the stability of the financial system to prevent substantial disruptions in vital financial services necessary for stable economic growth. The stability of a financial system is at greater risk when institutions and investors have high leverage and are overly reliant on long-term debt. High financial vulnerability increases the likelihood that a negative shock would cause market distress as well as other negative externalities to the relevant industry and to other related industries. MPTs aim to reduce the financial system's sensitivity to shocks by limiting the build-up of financial vulnerabilities.

The literature discussing MPTs focuses on their effects on the stability of the financial system, mostly from the point of view of regulators and financial institutions, rather than on behavior of the individual mortgage borrower. As such, some of the studies find that during downturns in the residential real estate market, loan-to-value (LTV) limits lower bank losses. Moreover, aggregate cross-country studies find that LTV limits are effective in moderating the increase in house prices, thereby reducing the risks and consequences of bubbles in real estate markets. However, there is a lack of studies on the effectiveness of such constraints from the borrowers’ perspective.

In a new paper, we study the effects of several macroprudential policy tools on household choices in the mortgage market. Using unique and detailed data on mortgage loans taken in Israel between the years 2011-2016, we empirically estimated the impact of these restrictions on household choice and, as a result, on the housing market. More specifically, we examined the borrowers’ response to the following macroprudential policy tools:

  1. Loan-to-value (LTV) limits: LTV limit of 75% for first time buyers, LTV limit of 70% for home improvers, and LTV limit of 50% for investors.
  2. Changes in the required capital adequacy of the banks: Housing loans with LTV ratio under 45% will be weighted as 35%, housing loans with an LTV ratio of between 45% and 60% will be weighted as 50%, and housing loans with an LTV ratio of 60─75% will be weighted as 75%.
  3. Payment-to-income (PTI) limit of 50%.
  4. Limit of 2/3 on the adjustable rate component of the mortgage.
  5. Maturity limit of 30 years.

We found that the regulatory provisions tested did not always influence the borrower as expected by the regulator. For two macroprudential tools tested, the regulatory limit served as an anchor for the borrowers and influenced their decisions. Specifically, we found an increase in mortgage loans maturity following the introduction of maturity limits and an increase in the PTI ratio following the introduction of PTI limits.

We suggest that the anchoring and adjustment heuristic may have influenced households’ decisions in such manner that they perceived the maximum PTI and maturity limits as a relevant anchor and consequentially increased mortgage PTI ratio and maturity. These results can be treated as unintended consequences of the regulatory provisions by showing a gap between ‘law on the books’ and ‘law in action’. The main goal of MPTs is to reduce systemic risks but, de facto, it may achieve the opposite.

Since housing is the most important asset in the portfolio of most households, the effect of behavioral biases can lead decision makers to systematic errors that, in turn, can cause a substantive loss of economic value. A better understanding of the effect of these heuristics on mortgage borrowers’ decisions can improve the design of market reforms in this area to maximize market efficiency and minimize households’ economic losses. Our research suggests that the anchoring and adjustment heuristic should be carefully considered before making regulatory interventions that impose maximum limits, to avoid possible unintended consequences.

Moran Ofir is an assistant professor at the Harry Radzyner School of Law, Interdisciplinary Center (IDC), Herzliya.

Yevgeny Mugerman is an assistant professor in the Finance Department at Bar-Ilan University, Ramat-Gan.