What happened to PMI?
April 6, 2009 9:50 AM Subscribe
Why hasn't private mortgage insurance (PMI) softened the blow of the real estate implosion?
You can't turn on the TV these days without hearing about the mortgage implosion. People are walking away from their severely depreciated homes and leaving the banks scrambling to make up for the shortfall between the remaining mortgage balance and the current home value. One thing I don't understand however, is why private mortgage insurance hasn't softened the blow. Isn't it supposed to make the lender whole if the homebuyer walks away and stops paying? I know you are no longer obligated to pay it after you have 20% equity in your home, but I'm assuming most of the subprime borrowers defaulting on their loans had exotic mortgages that did not require them to put down large down payments (if any). I'm hoping someone knowledgeable in the mortgage industry can shed some light on this.
You can't turn on the TV these days without hearing about the mortgage implosion. People are walking away from their severely depreciated homes and leaving the banks scrambling to make up for the shortfall between the remaining mortgage balance and the current home value. One thing I don't understand however, is why private mortgage insurance hasn't softened the blow. Isn't it supposed to make the lender whole if the homebuyer walks away and stops paying? I know you are no longer obligated to pay it after you have 20% equity in your home, but I'm assuming most of the subprime borrowers defaulting on their loans had exotic mortgages that did not require them to put down large down payments (if any). I'm hoping someone knowledgeable in the mortgage industry can shed some light on this.
A way to get out of paying PMI was to get what's called an 80/20 - essentially, two mortgages, one for 80% of the value, one for 20%. One of them would have a higher rate than the other (I believe the 20%) but it usually worked out to be cheaper than PMI.
posted by restless_nomad at 10:02 AM on April 6, 2009
posted by restless_nomad at 10:02 AM on April 6, 2009
I think PMI doesn't kick in until the bank has recouped what it can after foreclosure and subsequent sale of said property. Any eventual monetary reimbursement does not help the glut of homes on the market and since it could take a long time to get that reimbursement, banks would still have money technically tied up in those properties. Hence, less money to loan and tighter restrictions on the money that is loaned. PMI also does not help those who lost their homes, or businesses in the construction industry which has slowed down tremendously and the trickle down effect of the whole mess.
This is all from my feeble, non expert mind however.
What i still don't get is why noone in the mortgage industry seems to remember all the banks and savings and loans failing in teh 80s. A small bank in OKC failing had huge impact nationally in the not so distant past. Heaven forbid the greedy learn from others mistakes.
posted by domino at 10:04 AM on April 6, 2009
This is all from my feeble, non expert mind however.
What i still don't get is why noone in the mortgage industry seems to remember all the banks and savings and loans failing in teh 80s. A small bank in OKC failing had huge impact nationally in the not so distant past. Heaven forbid the greedy learn from others mistakes.
posted by domino at 10:04 AM on April 6, 2009
restless_nomad: I've never heard of an 80/20 before, though I don't doubt it exists... I did an 80/15/5... 5% down payment, 80% first mortgage, 15% second at a slightly higher rate... definitely worked out to be cheaper than PMI.
80/20 sounds insane... no down payment required at all just seems a little nutty / irresponsible.. but then, that's what the whole industry was, so... I shouldn't be surprised...
posted by twiggy at 10:15 AM on April 6, 2009
80/20 sounds insane... no down payment required at all just seems a little nutty / irresponsible.. but then, that's what the whole industry was, so... I shouldn't be surprised...
posted by twiggy at 10:15 AM on April 6, 2009
Ours was an 80/20. At the time the mortgage was written, we had good jobs with a combined annual income amounting to about 1/3 of the purchase price of the home, and some fairly substantial consumer debt. We now are in good financial shape and will have no problem (FSM willing) making our payments, but it definitely was a risky loan for the bank; we were even urged by the lender to go interest only. They really were just throwing money around a few years ago.
posted by MrMoonPie at 10:29 AM on April 6, 2009 [1 favorite]
posted by MrMoonPie at 10:29 AM on April 6, 2009 [1 favorite]
4 yrs ago we did an 80/20, with the 80 being 7-yr ARM. The 80 at 5.6%, the 20 at a floating 7.9%. This was definitely better for us than 100% at 5.6% + PMI. We wanted a house but at $0 for a down payment (in fact, we had the seller pay closing costs).
Our thinking was before the 7-yrs was up, we'd either move or refi. In case of a refi, the hope would be that market appreciation took our equity above the 20% level and we could do a 30- or 15-yr fixed with no PMI.
The market appreciation probably ain't gonna happen, but at least 2 things have occurred:
1. The floating 7.9% is now at 5.0%, so our payment is lower it was before (and even lower than if we could've magically financed 100% at the 5.6% with no PMI).
2. In the current rate enviroment, we can refi the 7-yr ARM at lower than 5.6% if we needed to.
posted by glenngulia at 10:46 AM on April 6, 2009
Our thinking was before the 7-yrs was up, we'd either move or refi. In case of a refi, the hope would be that market appreciation took our equity above the 20% level and we could do a 30- or 15-yr fixed with no PMI.
The market appreciation probably ain't gonna happen, but at least 2 things have occurred:
1. The floating 7.9% is now at 5.0%, so our payment is lower it was before (and even lower than if we could've magically financed 100% at the 5.6% with no PMI).
2. In the current rate enviroment, we can refi the 7-yr ARM at lower than 5.6% if we needed to.
posted by glenngulia at 10:46 AM on April 6, 2009
80/20 sounds insane.
What was more insane was that the /20 loans were also packaged into CDO instruments and tranched into AAA/B investment ratings. (While I dimly remember reading somewhere that most banks kept the junior lien, doing some quick googling (search for closed-end second-lien) I see that securitization of these piggy back loans started in 2003.
2003 . . . that's when the housing boom got started. Prices are a function of affordability and how much risk the lender is willing to take, and affordability is a function of interest rates, down payment requirements, and amortization requirements.
The bubble was pumped by relaxing all three 2003-2006. Basic Economics FTW!
posted by mrt at 10:58 AM on April 6, 2009
What was more insane was that the /20 loans were also packaged into CDO instruments and tranched into AAA/B investment ratings. (While I dimly remember reading somewhere that most banks kept the junior lien, doing some quick googling (search for closed-end second-lien) I see that securitization of these piggy back loans started in 2003.
2003 . . . that's when the housing boom got started. Prices are a function of affordability and how much risk the lender is willing to take, and affordability is a function of interest rates, down payment requirements, and amortization requirements.
The bubble was pumped by relaxing all three 2003-2006. Basic Economics FTW!
posted by mrt at 10:58 AM on April 6, 2009
NPR's excellent Planet Money podcast did a show about this question in November.
posted by donajo at 10:58 AM on April 6, 2009
posted by donajo at 10:58 AM on April 6, 2009
It got tricky when the insurer itself was insolvent (AIG) and couldn't make good on default loans. It's not PMI directly, so it doesn't really answer your question. But it goes something like this. Due to a weird loophole and no real oversight, AIG Financial Products division started issuing “insurance” for the CDO instruments that didn't need to be backed up by actual money. These are Credit Default Swaps, and although they were respected like insurance, they were actually derivatives. It was pretty much a shell game, moving money around long enough that no one even really knows what the money actually *bought*. Big surprise that when the CDO's tanked there wasn't actually enough money in all of AIG to pay up. And if AIG goes down, then so do all the companies stuck owning the junky CDO's. Thus the bailout. And thus the anger over the bonuses given to the fraudulent gamblers at AIG Financial Products who, in part, caused this whole mess.
So in the case of PMI (and unlike credit default swaps), the insurer has to show that they could plausibly cover the cost of a default mortgage. CDO's and subprime mortgages thrived because there was greater demand than supply. The standards for a good loan were relaxed because it was perceived that the risk was mitigaged - through CDO's and credit default swaps. PMI (real insurance) works for the little guy, but not for big companies that started gambling with other people’s money and lost.
Seconding the NPR specials produced by Planet Money and This American Life. There are 3 in the series so far. I hope they keep making more.
Also – the Rolling Stone article “The Big Takeover” is fantastic. http://www.rollingstone.com/politics/story/26793903/the_big_takeover
posted by degrees_of_freedom at 1:49 PM on April 6, 2009
So in the case of PMI (and unlike credit default swaps), the insurer has to show that they could plausibly cover the cost of a default mortgage. CDO's and subprime mortgages thrived because there was greater demand than supply. The standards for a good loan were relaxed because it was perceived that the risk was mitigaged - through CDO's and credit default swaps. PMI (real insurance) works for the little guy, but not for big companies that started gambling with other people’s money and lost.
Seconding the NPR specials produced by Planet Money and This American Life. There are 3 in the series so far. I hope they keep making more.
Also – the Rolling Stone article “The Big Takeover” is fantastic. http://www.rollingstone.com/politics/story/26793903/the_big_takeover
posted by degrees_of_freedom at 1:49 PM on April 6, 2009
Why hasn't private mortgage insurance (PMI) softened the blow of the real estate implosion?
The answer is very simple. Sub-prime loans did not require PMI even if the down payment was zero. The banks charged these borrowers much higher interest rates to compensate for the risk of non-payment. Obviously they calculated the risk incorrectly. The banks essentially chose to self-insure and keep the extra money for themselves. They wouldn't have been able to lend to as many borrowers if they had required PMI because the borrowers wouldn't have been able to afford it.
posted by JackFlash at 1:50 PM on April 6, 2009 [1 favorite]
The answer is very simple. Sub-prime loans did not require PMI even if the down payment was zero. The banks charged these borrowers much higher interest rates to compensate for the risk of non-payment. Obviously they calculated the risk incorrectly. The banks essentially chose to self-insure and keep the extra money for themselves. They wouldn't have been able to lend to as many borrowers if they had required PMI because the borrowers wouldn't have been able to afford it.
posted by JackFlash at 1:50 PM on April 6, 2009 [1 favorite]
Adding on to JackFlash, I think also the banks assumed that the houses would appreciate so fast that, even if the borrower defaulted, the bank would get its money back from the sale of the much-appreciated house (and then some). I guess it's not a bad gamble, as long as prices are rising rapidly.
posted by MrMoonPie at 3:01 PM on April 6, 2009
posted by MrMoonPie at 3:01 PM on April 6, 2009
A major issue is that many of the private mortgage insurers themselves are in the process of failing and may arguably be insolvent and not able to make good on all the claims that materialize.
Look at the stock prices for tickers PMI, RDN, MGT and TGIC. They are all basically worthless, and their credit ratings are in junk territory and falling by the quarter. Anyone holding bad paper backed by this insurance would have to mark it down commensurately.
A similar situation to what you are asking about is in the bond insurance world, where theoretically it should have also softened the blow of the real estate collapse, but it also toppled right along with it. In fact the contagion was even more pervasive. The bond insurers traditionally only guaranteed ultra-safe municipal bonds, but in recent years to juice revenues they started guaranteeing structured finance products (like RMBS CDO's) that ended up being toxic. The ensuing downgrades (and arguable insolvency) of many of the bond insurers (eg, MBIA, Ambac, Syncora, CIFG) has not only not helped the real estate market at all, but it has also caused widespread downgrades in the ultra-safe municipal bond world, which should never have been allowed to happen.
Right now MBIA is in the process of trying to split its insurance operations into two subsidiaries -- the good (municipal) and the bad (runoff structured finance)-- in an attempt to salvage its franchise and allow it to renew its ability to write municipal business. It's fascinating because some of the insureds left behind in the bad company are suing MBIA for depriving them of potential claims-paying assets. And they are right, even though the split makes perfect sense for the company and the broader financial markets.
posted by jameslavelle3 at 6:19 PM on April 6, 2009
Look at the stock prices for tickers PMI, RDN, MGT and TGIC. They are all basically worthless, and their credit ratings are in junk territory and falling by the quarter. Anyone holding bad paper backed by this insurance would have to mark it down commensurately.
A similar situation to what you are asking about is in the bond insurance world, where theoretically it should have also softened the blow of the real estate collapse, but it also toppled right along with it. In fact the contagion was even more pervasive. The bond insurers traditionally only guaranteed ultra-safe municipal bonds, but in recent years to juice revenues they started guaranteeing structured finance products (like RMBS CDO's) that ended up being toxic. The ensuing downgrades (and arguable insolvency) of many of the bond insurers (eg, MBIA, Ambac, Syncora, CIFG) has not only not helped the real estate market at all, but it has also caused widespread downgrades in the ultra-safe municipal bond world, which should never have been allowed to happen.
Right now MBIA is in the process of trying to split its insurance operations into two subsidiaries -- the good (municipal) and the bad (runoff structured finance)-- in an attempt to salvage its franchise and allow it to renew its ability to write municipal business. It's fascinating because some of the insureds left behind in the bad company are suing MBIA for depriving them of potential claims-paying assets. And they are right, even though the split makes perfect sense for the company and the broader financial markets.
posted by jameslavelle3 at 6:19 PM on April 6, 2009
Response by poster: In a related question, who are the main PMI insurance companies? And where did all the premiums go? And if PMI is essentially useless to the borrowers and the lenders, why not get rid of it?
posted by GatorFan2000 at 11:00 AM on April 7, 2009
posted by GatorFan2000 at 11:00 AM on April 7, 2009
According to my sources at Countrywide, they are too busy working the short sale and foreclosure files to file claims against the mortgage insurance companies. These lenders are far less organized than we think; their employees are often clueless, and turnover is very high. There may be a "Work Out" department to help borrowers through short sales and foreclosures, but there is no "File Claims Aganst The PMI Companies" department. Dur. This kind of stupidity is just indicative of the cause of the problem in the beginning.
posted by orangemiles at 11:42 AM on April 7, 2009
posted by orangemiles at 11:42 AM on April 7, 2009
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posted by MrMoonPie at 9:57 AM on April 6, 2009