By Jack Guttentag
Saturday, May 24, 2008
In my last several columns, I have discussed a proposal for a new type of mortgage insurance that I think would help solve many of the problems with the current mortgage system.
With mortgage payment insurance, the insurer would guarantee timely payments to loan investors after borrowers default. If the default is not corrected, payments from the insurer would continue until the foreclosure process is completed, at which point the investor would be reimbursed for the unpaid balance, including unpaid interest, plus foreclosure costs.
The idea for MPI came from a friend of mine, who has a patent pending. I have an interest in that patent. No insurers offer MPI.
Such a system could reduce costs for insurers and borrowers because investors would not demand higher interest to cover payment risk. Such a system would also be less vulnerable to serious default episodes, such as the one we are in now. More reserves would be available to meet the losses that occur, reducing the erosion of investors' capital. Underwriting would shift to insurers that have a long-run orientation and are not caught up in short-term swings in market sentiment. Keeping defaulted mortgages in good standing until they are paid off would moderate the contagious erosion of investor confidence that stems from rising numbers of nonperforming loans.
But there is a problem in getting there from where we are now. The core benefit of MPI is the elimination of interest rate risk premiums at little or no cost to the insurer. However, that can happen only if investors have complete confidence in the insurers. That would not have been a problem two years ago, when all the mortgage insurance companies were rated AA or AAA. It is a problem today because the insurers have been weakened by their large payouts on foreclosed loans, and they have all been downgraded.
What would be needed to make the jump would be an option for insurers to buy reinsurance from a government agency that would commit to making the mortgage payments if the private insurer could not. This is the same type of guarantee that the Government National Mortgage Association, known as Ginnie Mae, provides on securities issued against pools of Federal Housing Administration and Department of Veterans Affairs mortgages.
Ginnie Mae has charged 6 basis points for its guarantee. (A basis point is one-hundredth of a percentage point, so the agency charges $6 per year for every $10,000 it guarantees.) The agency has been a consistent source of profit for the government. I would expect a similar guarantee fee on privately insured loans and a similar experience. Ginnie Mae's reinsurance would come into play only if the private insurer went broke.
There is no reason why a benefit directed to one industry should be permanent, and once the market has been normalized and the insurers have built their reserves, there should be no further need for it. A good way to minimize the support period is to build automatic premium increases into the program, providing a strong incentive for the insurers to rebuild their capital as quickly as possible.
With Ginnie Mae backstopping MPI, investors -- including Fannie Mae, Freddie Mac and investment banks -- should pay a price based on the prime rate. Since borrowers will know what the prime rates are, the lenders who sell to the secondary market and the brokers who feed loans to those lenders, will compete on their markups over the prime rate and on service.
Insurers would be positioned to reduce borrower costs on purchase loans and refinances. They would also be able to use MPI to modify contracts on loans currently in default, reducing the number that go to foreclosure.
Why should the federal government provide special support to the mortgage insurance industry? The major reason is that it will turn the market around at a critical time, while initiating a reform process that will make the entire housing finance system less vulnerable and more equitable.
It would not be an industry bailout -- the probability that the liability assumed by Ginnie Mae would ever cost the government anything is small. Indeed, it could more accurately be viewed as a bailout prevention measure, eliminating the need for the more extensive government support that will become necessary if the situation deteriorates further.
Jack Guttentag is professor emeritus of finance at the Wharton School of the University of Pennsylvania. He can be contacted through his Web site,http://www.mtgprofessor.com.
© 2008 Jack Guttentag
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