Working Paper: NBER ID: w24844
Authors: Neil Bhutta; Benjamin J. Keys
Abstract: In the U.S. mortgage market, private mortgage insurance (PMI) is mandated for high-leverage mortgages purchased by Fannie Mae and Freddie Mac to serve as a private market check on GSE risk-taking. However, we document that PMI firms dramatically expanded insurance on high-risk mortgages at the tail-end of the housing boom, contradicting the industry's own research regarding house price risk. Using three detailed sources of mortgage and insurance data, we examine PMI application denial rates, default rates on PMI-backed loans, and growth rates of high-leverage lending around the GSE conforming loan limit, along with information extracted from company, industry and regulatory filings and reports. We conclude that PMI behavior during the housing boom in part reflects a "moral hazard" incentive inherent to insurance companies in general to underprice risk and be undercapitalized. Our results suggest that rather than providing discipline, private mortgage insurers facilitated GSE risk-taking.
Keywords: Mortgage Insurance; Moral Hazard; Housing Boom; Risk Exposure
JEL Codes: G21; G22; L10; L14
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| PMIs facilitated GSE risk-taking during the housing boom (G21) | PMIs underpricing risk and being undercapitalized (G32) |
| PMIs' incentives to generate premium revenue (G52) | excessive risk-taking (G41) |
| PMIs' issuance of insurance on high-risk mortgages (G21) | increased risk-taking by GSEs (G21) |
| decline in piggyback lending (G51) | surge in PMI issuance (E60) |
| PMIs exacerbated risk-seeking behavior of GSEs (G21) | PMI growth concentrated in markets with declining house prices (R31) |
| PMIs' underwriting practices (G52) | overall risk exposure in the mortgage market (G21) |