This paper examines the effect of financial literacy on mortgage stress. Using data from the Panel Study of Income Dynamics (PSID), we find that borrowers with high levels of financial literacy are 60.3 percent less likely to suffer from mortgage stress than borrowers with low levels of financial literacy after controlling for observables. Our estimated results are robust to potential sample selection bias and functional mis-specification. In addition, we also find that the effect of financial literacy varies across borrowers of different ages. Further analysis reveals strong cross effects of financial literacy and quantitative reasoning on mortgage stress.

We investigate housing market distortions with the collusion of agents. The agency problem where agents sell clients' houses with price discounts while selling their own homes with price premiums is quite straightforward. However, the issue that agents collude with each other to further maximize their own interests is elusive. When agents collude, the resulting market distortions may even be worse than previous studies suggested. Indeed, this paper finds that the agency problem and market distortions are much more severe with agent collusion, as both the discounts associated with clients' houses and the premiums with agents' own homes become much larger when the two agents collude.

Real estate transactions are often established through financing. We study the effect of financing on property prices. We show that properties can transact at prices well above their collateral values. Therefore, the commonly used loan-to-value (LTV) ratio suffers a bias that can significantly understate credit risk. This bias is exacerbated when mortgages are originated with longer terms, at higher LTV ratios, or when sellers possess stronger bargaining power. Furthermore, this bias is larger under aggressive lending products, e.g. interest-only loans and mortgages allowing negative amortization. Our simulation results suggest that many mortgages originated at the peak of the housing bubble are, in fact, “under water” at origination. In particular, the loan amount of a 30-year mortgage at a 95% LTV can be 15% greater than the collateral value of the property, suggesting the mortgage is already deep “under water” at origination. These findings call into questions underwriting and risk control practices in mortgages and other collateralized debts.