When Irving H. Plotkin first examined the private mortgage insurance industry in 1975, the business looked like a "money machine," in his words.
Insurance companies were practically running to get a piece of the action in the growing business of guaranteeing mortgage lenders against default on loans by home buyers. But Plotkin, an economist with Arthur D. Little Inc., saw some potential pitfalls lurking ahead, and in a widely noted report he warned against underpricing, poor underwriting and other problems that could cripple the industry's progress.
Plotkin's words of warning sound virtually prophetic today. Record default rates have flooded the nation's 13 mortgage insurance companies with unprecedented underwriting losses.
Some $2 billion in claims have been paid out this decade already, executives say, and the collapse of the EPIC real estate syndication empire threatens another $350 million in losses.
Will the fledgling industry come through healthy?
This was the main question Plotkin, several industry executives and dozens of housing finance officials sought to answer this week at a special conference organized by the Mortgage Insurance Companies of America, the industry's trade group.
The answer they gave was "yes -- but barely." Intense price competition, sloppy underwriting, a misreading of the economic environment and too much experimentation with risky loan instruments were among the prime culprits cited for the industry's woes in the past five years.
The key to continued solvency during this period was that the companies had built up adequate reserves to pay for the losses, the experts agreed. If these reserves can be built back up -- and if the companies continue to improve their pricing and underwriting practices -- a return to sustained profitability and health was seen as possible.
"We have gone through some very difficult times . . . and we have survived. Not only have we survived, but we are relatively healthy," C. Earl Corkett, chairman of PMI Mortgage Insurance Co. and one of the panelists, said of the industry.
The industry's problems today were in many ways spawned by companies departing from basic principles developed when Mortgage Guaranty Inurance Corp. of Milwaukee was established in 1957.
Private mortgage insurance disappeared after the Depression, leaving the market to the Federal Housing Administration and the Veterans Administration. It reappeared again after companies saw a huge potential market in insuring homeowner loans not covered by these government agencies.
The companies would offer to protect lenders for about 20 percent of the value of a mortgage loan, on the theory that, in a default, the rest of the amount could be recovered through foreclosing and selling the house.
Thus, borrowers who make a down payment of 20 percent or more generally have not been required to buy mortgage insurance.
Although the premium for this type of insurance made the cost of mortgages a little more expensive, its existence also convinced savings and loans and other lenders to make mortgage loans they otherwise might have refused to borrowers who could make only a small down payment.
The business boomed for most of its young life, and today the 13 private mortgage insurers insure more loans than the government agencies combined -- about 70 percent of all insured loans -- with some $200 billion of insurance in force, according to trade association figures.
Along the way, however, these companies stumbled.
In discussing the industry trends over the past decade, the seminar's panelists stressed the role of inflation in inducing risky underwriting and pricing practices among companies.
During the 1970s, when housing prices were appreciating at a rapid clip, companies rushed to insure many loans, often without regard for the nature and the cost of the risk they were taking on.
When housing prices slowed in the 1980s, record numbers of homeowners, many of whom put little of the cost of the house down in the first place, defaulted on their mortgage obligations. The insurers were left holding the bag.
Complicating the situation was that the insurers have been branching away from traditional fixed-rate mortgages to insure a host of complicated mortgage instruments, starting with adjustable-rate mortgages and graduated-payment mortgages, and extending into various kinds of mortgage-backed securities.
"What were you writing? That's really the problem," Plotkin told the executives. "It is very difficult to underwrite a mortgage instrument that you don't really understand." The industry, in intense competition for market share, priced insurance far too cheaply relative to the kind of risk the companies were assuming, he said.
As the executives who were at the conference told it, the industry has learned its lesson, albeit at a high cost.
They said that the existence of adequate contingency reserves has been critical to their continued solvency. State regulators do not allow companies to take on more than 25 times their capital and reserves and have been diligent in enforcing this rule, according to panelists.
The companies since 1984 also have been seeking to tighten their underwriting standards and increase prices, changes the executives said should help stem the red ink.
"We have forgotten all about market share. . . . The name of the game is underwriting," said Leon T. Kendall, chairman of Mortgage Guaranty Insurance.
The problem, however, is that most companies still retain on their books much of the problem business that was taken on before the industry cleaned house, and only time will weed out the bad risks. Plotkin and other panelists expressed confidence, though, that the most severe losses have subsided.
The companies "have come through a tumultuous period and have not defaulted on any obligations," Plotkin said. "I think they got by -- just by the skin of their teeth."