The Mortgage Insurance Companies

[jillayne]

This is another dark horse in the race to the bottom:

http://www.calculatedriskblog.com/2009/ ... urers.html

"We believe that several of our mortgage insurance counterparties are at risk of falling out of compliance with regulatory capital requirements, which may result in regulatory actions that could threaten our ability to receive future claims payments, and negatively impact our access to mortgage insurance for high LTV loans. Further, one or more of these mortgage insurers, over the remainder of 2009 or in the first half of 2010, could lack sufficient capital to pay claims and face suspension under Freddie Mac's eligibility requirements for mortgage insurers."

One OR MORE of the MI companies.

If we see one or more MI company failures, this will lead to further tightening of conventional underwriting guidelines into 2010, squeezing more people out of the homebuying market, or home refinancing machine, and even more downward pressure on home prices in the jumbo category.

[TJ_98370]

So, let's see if I understand this correctly. There is no federal oversight for private mortgage insurers (PMI). Individual states regulate PMI's. However, we the taxpayers are going to be responsible for the bad debt resulting from defaults on Freddie Mac / Fannie Mae loans that may not be covered because of insolvent PMI's. And the reason the PMI's may become insolvent is because they did not take proper precautions regarding risk with their counterparties. The National Association of Insurance Commissioners is strongly opposed to federal regulation of PMI's, yet when they don't do their job right, they suffer no consequences. All the tax-payers in the country get to pay for the bad judgement of the PMI risk managers and of the state insurance commissioners.
.
Do I have this right?

[Courtney]

I don't think lack of regulation is the problem. And ridiculous risk-taking isn't the problem either. If people want to make bad business choices, fine, let them.

The problem is that the government bails them out, punishing taxpayers, instead of letting the companies and their customers suffer the consequence of poor choices. If firms see bad business practices resulting in failure and massive loss of capital, they will naturally be deterred from taking wild risks, as will potential customers.

Instead, companies see that the government feels justified letting the American taxpayers take the hit for their idiotic decisions. More firms will naturally respond to this incentive by taking on even more risky projects in the future, so long as they trust they will be bailed out.

There will always be some innocent people who get hurt when bad businesses fail, but we should respond to those individual cases rather then sucking the entire country into a black hole. And TJ, I know regulation wasn't your primary point at all, but I was overdue for a tangent.

[TJ_98370]

.
There definitely seems to be a problem regarding moral hazard in this situation. It is a common theme amongst real estate finance recently. The risk of default was so successfully obscured either by fancy statistical math modeling, misrepresentation, incompetence, or even greed that loan originators were able to push ever more risky loans onto banks and mortgage insurance companies. For the PMI's to be threatened by insolvency means that they did not accurately evaluate the real risk of defaults. For Freddie Mac (and the taxpayers) to be ultimately responsible for bad risk management of PMI's and their counterparties indicates incompetency at the federal oversight level.
.
I think it reasonable to assume that any rational person would not willingly take on risk without knowing what that risk is and having some control over the amount of risk taken on. Yet, according to the article linked above, that is apparently what Freddie Mac did.