Editor: David Reiss
Brooklyn Law School

September 2, 2014

Insuring Mortgages Through the Business Cycle

By David Reiss

Mark Zandi and Cristian deRitis of Moody’s, along with Jim Parrott of the Urban Institute, have posted Putting Mortgage Insurers on Solid Ground. They wrote this in response to the Private Mortgage Insurance Eligibility Requirements set forth by the FHFA. While generally approving of the requirements, they argue that

Several features of the rules as currently written, however, would likely
unnecessarily increase costs and cyclicality in the mortgage and housing markets.
With a few modest changes, these flaws can be remedied without sacrificing the
considerable benefits of the new standards. (1)

I would first start by reviewing their disclosure:  “Mark Zandi is a director of one mortgage insurance company, and Jim Parrott is an advisor to another. The authors do not believe that their analysis has been impacted by these relationships, however. Their work reflects the authors’ independent beliefs regarding the appropriate financial requirements for the industry.” While, I understand that the authors believe that their views are not impacted by their financial relationships with private mortgage insurers, readers will certainly want to take them into account when evaluating those views.

The authors argue that FHFA’s requirements are procyclical, that is they become more burdensome just as mortgage insurers are facing a distressed environment. This could contribute to a vicious cycle where mortgage credit tightens because of regulatory causes just when we might want credit to loosen up. This is certainly something we should look out for.

They also argue that the FHFA’s requirements will increase mortgage insurance premiums unnecessarily because they increase capital reserves too much. I find this argument less compelling. The Private Mortgage Insurance industry has typically done terribly in distressed environments from the Great Depression through the 2000s. Not only have there been failures but they have also reduced their underwriting of new insurance just when the market was most fragile.

But there are certain shaky assumptions built into this analysis. For instance, they argue that Private Mortgage Insurance companies will need to maintain their historical after-tax return on capital of 15%. But if the business model is shored up with higher capital reserves, investors should be satisfied with a lower return on capital because the companies are less likely to go bust. That is, instead of increasing premiums for homeowners, it is possible that higher capital requirements might just reduce profits.

The authors write that while “the increase in capital requirements is clearly warranted, there are certain features of the requirements as currently drafted that will increase mortgage insurance premiums unnecessarily, running counter to the aim of policymakers, including the FHFA, to encourage greater use of private capital in housing finance.” (2-4) Policymakers have lots of goals for private mortgage insurance, including having it not implode during down markets. An unthinking reliance on private capital is not what we should be after. Rather, we should seek to promote a thoughtful reliance on private capital, taking into account how we it can best help us maintain a healthy mortgage market throughout the business cycle.

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