Taxpayers and Homeowners Share the Same Risk Regardless of Politics
Wednesday, February 3, 2016
The ongoing policy debate regarding the federal government's role in the housing marketplace often pits taxpayers against homeowners, as if their goals are separate and somehow incompatible.
Although the national rate of homeownership has dropped to a 48-year low of 63 percent, the fact still remains that the taxpayer on one side of the debate, is also the homeowner on the other side almost two-thirds of the time.
As a result, the oft-repeated argument, "the taxpayers are on the hook for the homeowners' mortgages," is at best misstated.
When one considers that the homeowner demographic and the taxpayer are in fact one and the same, the question of policy solutions becomes far more practical and productive than the unending politically-tinged wrestling match we're used to hearing in Washington.
Consider the concept of "credit risk transfer."
Far more understandable than the name alone might lead one to believe, credit risk transfer allows the taxpayer to share the burden of large-scale mortgage repayment risk with the private sector that is incentivized to bear this risk. It also allows the homeowner continued access to 30-year mortgages at competitive, yet affordable fixed rates. And the fact that the homeowner and taxpayer are often one in the same makes this more than just a housing finance term or policy initiative. It's common sense, plain and simple.
Under the current mortgage finance operating model, mortgage giants Fannie Mae and Freddie Mac (commonly referred to as the Government Sponsored Enterprises, or "GSEs") acquire mortgages from lenders and then package and sell them to investors. The homeowners to whom the mortgages are granted have an ongoing obligation to repay the principal and interest costs of these loans. In the event that a homeowner fails to pay their mortgage, the GSEs are obligated to pay at least some of the difference to the investors. The risk described here is called "credit risk" and the GSEs have a great deal of it. Reasonable estimates on their $4.5 trillion book of mortgages is that they carry about $200 billion of real risk outlays at any given time - even more if the economy turns sour and mortgage defaults spike.
If GSEs can't cover the payments, the U.S. Treasury provides a backstop made up of your taxpayer funds. Today that backstop exists in the form of the GSEs under the 89th consecutive month of government conservatorship.
The U.S. taxpayer bears the ultimate burden and threat of having to (repeatedly) bail out the GSEs.
The FHFA - the GSEs' assigned federal regulator agency - has been working to find private sector companies willing to assume this roughly $200 billion of credit risk. As one could probably guess, this is no simple or easy task.
In recent years the GSEs have started to spread significant portions of this risk through mind-numbingly complicated transactions involving complex securities, contracts and debt offerings. In late 2015, the GSEs committed to another year of this program.
But there is a more simple and easy solution. It's called Deeper Cover Mortgage Insurance.
In Deeper Cover Mortgage Insurance the GSEs transfer primary credit risk on the loans it guarantees through the use of expanded credit enhancement on a loan-by-loan basis provided by private mortgage insurers. In essence, if a homeowner stops paying their mortgage, the private mortgage insurance covers losses to investors after the home is sold - generally in a foreclosure or short sale. The most frequently discussed Deeper Cover Mortgage Insurance proposal would insure up to 50 percent of the loan. This is more than enough to make investors whole in even the toughest of economic downturns.
The insurance provided by Deeper Cover Mortgage Insurance could be executed cheaper than the GSEs' current fee structure for the same protections. Of course, in order for this form of credit risk transfer to be effective in reducing costs to homeowners, a commensurate reduction of GSE fees must reflect the greatly reduced risk of loss borne by the GSEs.
A recently completed study by the Milliman group researched this exact issue. Their findings conclude that Deeper Cover Mortgage Insurance reduced borrower costs by an average of $8 per month. That adds up to $2,300 over the life of an average homebuyer's loan.
This perfect marriage of homeowner savings and taxpayer protection is precisely why a number of groups including America's Homeowner Alliance support this method of Credit Risk Transfer.
Unfortunately, it seems the regulator wants to give the GSEs the ability to experiment with other kinds of Credit Risk Transfers. These alternatives might benefit the GSEs in the short term - but almost certainly not the homeowner.
While the GSEs are under the control of the government, we're making a plea to the regulator to use Deeper Cover Mortgage Insurance (the proven method of Credit Risk Transfer), to protect the taxpayer and benefit the homeowner as well. Almost two thirds of taxpayers are homeowners. Why should they be OK with the government experimenting with their tax dollars to benefit the government controlled GSEs? How about benefiting the taxpayer homeowner instead?