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The GSEs, PMIs, and the Banks

posted by Adam Levitin

Yves Smith at Naked Capitalism has a fascinating post about the GSEs and private mortgage insurance. The short of it is that the GSEs don't seem to be making claims on PMI policies despite being the loss payees. The reason why is that if the GSEs made claims on the PMIs, it would quickly render all of the PMIs not just insolvent, but illiquid (which is the real kiss of death). And if the PMIs went under, then the GSEs would have to take huge write-downs on all of the still performing loans with PMI insurance. Chris Whalen estiamtes that in order to avoid perhaps $100B plus in write-downs, the GSEs are forgoing several billion in PMI claims. If this is the case, it shows what a farce GSE regulation by FHFA is.

There's a further twist, however, that Yves post didn't capture. A lot of PMI is reinsured. And guess who does about half of PMI reinsurance? The captive reinsurance affiliates of the large banks.

While most large banks have reinsurance capitves, the captives of the big 4 banks get about 1/3 of all PMI reinsurance premiums, which probably translates to something like 1/3 of the exposure.  Just to list the biggest, that's Balboa Reinsurance (Countrywide/BoA); Bank of America Reinsurance (BoA); Cross Country Insurance (Chase); North Star Mortgage Guaranty Reinsurance (Wells Fargo). I haven't figured out the extent of this exposure, as not all PMI is reinsured, and not all reinsurance is first-loss position, but there is definitely some bank group skin on the line with PMI. 

What this all means is that if the GSEs are forbearing in making claims on their PMI policies, it not only hides the GSEs' losses.  It also means we're seeing another quiet bailout of the banks.

*****

In case you're interested in why banks' reinsurance captives are reinsuring PMI, it's a kickback game. The lender, not the homeowner picks the PMI carrier because they all charge the same rates and the homeowner is indifferent. The lender selects the PMI carrier based on the amount of business the PMI firm will cede to the lender's captive reinsurance subsidiary. And therein lies a regulatory capital game, as captive reinsurers aren't required to hold much regulatory capital at all, as there is jurisdictional competition for charters.  The biggest US chartering jurisdiction for captive insurance companies in Vermont (!) and looking at Vermont's captive insurance law, I don't see any regulatory capital requirements beyond a de minimis initial capitalization that isn't enough to buy a house in parts of DC.  

 

Comments

Great post. My question is what allows the GSEs(if we can still call them that) to avoid making claims? Aren't there fiduciary obligations they are failing? Congress needs to investigate the dealings of the GSEs, and I suspect jail time will result.

I can't help but wonder how long we will continue to prop up these insolvent TBTFs.

Hmm... pmi reinsurance... Could this be at least partially why The PMI Group, MGIC and Radian are tanking?

Professor, any thoughts as to why it was "fashionable" or more likely more profitable for the pmi insurers to own mortgage servicers up until roughly 2006 or so?

GSEs should not go for claims over PMI because it will be great loss. Probably that is the reason why things are going like that.

Are there any actual facts to back up this interesting series of speculative posts?

Adam your stuff is always on point and shining the light on the Banks dirty secrets. When the legal storm is over the PMI companies will certainly taste their share of the mud pie the mortgage banking industry is currently feeding the american middle class homeowner. http://diligencegroupllc.net/

Thanks again!

American Homeowner

-AH

There has alway been something tasteless about money lenders, going
way back historically. Now I'm beginning to see why.

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