Much has been written and discussed about the economic crisis and the mortgage meltdown and blame has been spread thin, but little attention has been paid to one group of important players in the mortgage industry. The role played by mortgage insurers, those companies that sold insurance to guaranty borrower mortgage payments, helping to facilitate the origination and sale of mortgage loans, has been largely ignored. In simple terms, mortgage insurers sell insurance to lenders to cover losses in the event that borrowers default on their mortgages. For loans where borrowers make a down payment that is less than 20 percent of the purchase price, mortgage insurance typically is required. Without mortgage insurance, such loans generally cannot be sold to the Government-Sponsored Enterprises (“GSEs”), Fannie Mae and Freddie Mac, or to other investors in what is called the secondary market.

Historically, without the ability to sell the loans they originated, lenders would have been unable to meet the demand for new mortgage loans and affordable housing goals set by the government, as there would be less liquidity in the market. Mortgage insurance also was used as a form of credit enhancement for mortgage-backed securitizations which helped the sponsors of those deals obtain credit ratings that made their offerings more attractive to investors. Much of these securitizations were made up of riskier subprime mortgages and second-lien loans, such as home equity lines of credit. Mortgage insurance, therefore, helped fuel the vast increase in mortgage lending that some say led at least in part to the financial crisis when the housing market collapsed. Mortgage insurers also helped facilitate and even encouraged lenders to originate riskier mortgage products as mortgage insurers needed more and more loans to be originated in order to expand their businesses. In addition, mortgage insurers could charge higher premiums to insure loans that involved higher levels of risk, so as long as home prices continued to rise as most everyone expected, the money could be raked in without the insurers having to face substantial claims activity.

This commentary will begin with a brief explanation of mortgage insurance and a summary of the history of mortgage insurance. We then discuss the financial collapse of the economy which caused an unprecedented rise in the volume of claims submitted to mortgage insurers. The commentary will next discuss how the mortgage crisis impacted the financial condition of the mortgage insurers which spurred them to change their behavior and how they handle claims. We also will discuss how mortgage insurers have largely escaped scrutiny for the mortgage crisis despite their role in helping to increase the origination of riskier loans. The mortgage insurance industry facilitated and encouraged more liberal underwriting standards which we will demonstrate through marketing materials published by these insurers. We will suggest that if the mortgage insurers had taken seriously their role as mangers of risk, perhaps the mortgage crisis would not have been so profound. We also will demonstrate that mortgage insurers ignored their own warnings. For instance, although they knew the risks associated with stated income loans and publicly warned about the perceived dangers associated with such loans, including the risk that borrowers would lie on loan applications about their incomes, they nevertheless agreed to provide insurance against the risk that stated income borrowers would default, charging higher premiums to account for the increased risk. Since the economy collapsed and claims began to roll in, mortgage insurers now say that they were somehow misled about the risks associated with these loans and they should be allowed to walk away from the risks they willingly undertook when they thought that the housing market would continue to grow.

Download the PDF to read more!