Theory of the Credit Surface

Instead of focusing on the risk-free interest rate, market participants and policymakers would be better off tracking the spread faced by borrowers when taking out mortgages. Given a FICO score, a household desiring a certain loan-to-value ratio would be charged an interest rate higher than the risk-free rate, albeit how much higher depends on the ambient environment of the economy including expectation of house price appreciation and the likelihood of default. We present a theoretical model of the credit surface which maps to the data and show the role played by economic objects other than the risk-free rate in determining what the interest on your mortgage ought to be.

Joint with John Geanakoplos (draft coming Summer 2019!)

A flat credit surface during a bull market.

A bloated credit surface in the aftermath of a bust.

A bloated credit surface in the aftermath of a bust.


What role did expectations play in driving up house prices in the early-2000s and what triggered the subsequent bust in the U.S. housing market. Could debt forgiveness have mitigated the collapse of housing prices? I explore these questions in a structural macroeconomic model without hard collateral constraints using the credit surface to ease the problem of mortgage design.

(Work in progress)

The Leverage Cycle and the Housing Market