AgentMarkets & Economy

Mortgage industry struggles to manage default risk

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An enormous amount of ink has been spilled on the mortgage market crisis, and I have contributed my share. Yet I am now convinced that the most important factor underlying the crisis, which has been in plain view all along, has been overlooked. It is the way in which the mortgage industry manages default risk. There are, in fact, two systems for managing default risk. In both, the borrower pays a premium scaled to estimates of the risk of the transaction. But, while one system has worked well, the other has been a disaster. The system that has worked well is mortgage insurance. Borrowers are required to purchase mortgage insurance if their down payment on a home purchase or their equity in a refinance is less than 20 percent. Mortgage insurance covers lender losses up to an agreed-upon coverage amount. The seven companies that now sell mortgage insurance place more than half of every premium dollar they collect from borrowers in reserve accounts. This is mandated by law. ...