Loan-to-value (LTV) caps are a widely used borrower-based macroprudential tool, premised on the idea that safer household balance sheets make the economy more resilient to downturns. We evaluate this premise in a general-equilibrium model with heterogeneous households, long-term defaultable mortgages, endogenous housing adjustment, and constrained banks. We find that lowering the maximum loan-to-value ratio from 100 to 20 percent eliminates almost all mortgage debt and downturn foreclosures, yet reduces the house-price trough after a productivity shock only marginally. The reason is fragile prudence: larger down payments protect incumbent balance sheets but prevent renters and owners from buying or upgrading when income, liquid wealth, and home equity weaken together. Mortgage limits stabilize more when shocks raise bank funding costs because such limits reduce banks’ exposure to long-duration mortgages; this bank-balance-sheet benefit diminishes as banks become better capitalized. More generally, even the modest stabilization after productivity shocks can reverse when banks’ marginal funding cost is externally priced. Borrower-based limits therefore provide effective microprudential insurance but are unreliable as macroprudential stabilizers.

We identify and study two mechanisms that can overturn the stabilizing effects of unemployment insurance (UI) policies. First, households in economies with more generous UI reduce their precautionary savings and borrow more in the mortgage market. Second, the overall share of mortgages as well as the share of mortgages with higher loan-to-income ratios on bank balance sheets increase. As a result, both bank and household balance sheets become more vulnerable to adverse shocks, which deepens recessions. We demonstrate the importance of these channels, by employing a quantitative heterogeneous-agent general equilibrium model and by providing county-level empirical evidence from the U.S. housing and mortgage markets.

While higher interest rates increase the payments for borrowers with adjustable-rate mortgages (ARMs), cutting their disposable income, higher rates also increase lenders' interest income, strengthening their balance sheets. We find, correspondingly, that—when monetary conditions tighten—banks with higher ARM shares see their stock prices increase, supply more credit, and obtain higher interest income compared to banks with lower ARM shares. Therefore, more ARM credit outstanding may weaken monetary policy transmission. And during a financial crisis, when interest income becomes critical for banks, reductions in interest rates may be challenging for those banks with very high ARM shares.

This paper investigates how mortgage structure shapes the transmission of inflation shocks through a "dual channel" where household wealth effects compete with bank credit supply.

We present two sets of evidence demonstrating that credit supply played a quantitatively significant role in the US housing market circa 2008. First, we develop a general equilibrium model featuring heterogeneous households who make housing tenure decisions and take out long-term mortgages, firms that acquire working capital through short-term bank loans, and banks whose ability to intermediate funds depends on their capital. Second, we provide bank- and county-level empirical evidence supporting the credit supply mechanism. Our quantitative findings show that changes in credit supply, stemming from exogenous shocks to bank leverage and/or endogenous shifts in bank balance sheets, played a significant role in the housing market boom-bust and the overall economy.

We show that higher monetary policy uncertainty lowers bank risk-taking, with especially poorly capitalized banks contracting their loan supply.