paper about MBS

5 a substantial portion $173 billion was issued by

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Unformatted text preview: 5%). A substantial portion -- $173 billion -- was issued by these six insurers to satisfy the guidelines of Fannie Mae and Freddie Mac. In terms of the relative size of private and government markets, in 2007, $357 billion was newly underwritten by private insurers, and $105 billion by the government insurers: FHA and VA. And from January 1, 2007, to December 31, 2007, the above insurers (which were publicly traded independent companies) lost an average 60% of their stock market capitalization. Almost all of them experienced financial distress the following year. Short of banning private mortgage insurance, or requiring heavy capitalization, it is not clear how the private market can solve the systemic risk problem. Reducing the size of the insuring firms will not work because all of the firms will fail at the same time given the macroeconomic nature of mortgage insurance risk. For all of these reasons, we are agnostic with respect to the complete privatization option, at least in the near future. However, if privatization was the chosen route, then the credit-risky MBS market would have to be given time to develop, and private mortgage guarantee functions may have to be fully capitalized. During the transition to privatization, the guarantees on the existing conforming mortgages would remain in place and be assumed by the GSE RTC. In addition, new conforming mortgages could be originated by the GSE RTC, but their numbers should be reduced gradually. The wind-down scenario for the guarantee function could be set up in a similar fashion as that 116 for the retained portfolio. In particular, new guarantees could fall at 10% per year from their 2009 peak, unless market conditions permit a faster wind-down. 8.2.3. A Hybrid Solution The question is how to balance the benefits of nationalization – the public guarantees of mortgages with its enhanced liquidity for the mortgage market -- against the difficulty in pricing these guarantees and the resulting lack of market discipline, which induces moral hazard and excess risk taking. With privatization, the exact opposite is true. While this problem appears to be intractable, there is a viable private option, in which the GSEs disappear, but all conforming mortgage-backed securities would still be guaranteed. The idea would be to form a public-private partnership for the guarantee business. Under this scenario, private mortgage securitizers would purchase mortgage loans from originators and issue default-free mortgage-backed securities. Instead of bearing the credit risk entirely themselves, private securitizers would purchase mortgage default insurance for the mortgage-backed securities. As in the previous approach, depending on the tranche structure of the MBS, mortgage insurance would only be necessary for a portion. But because this insurance still requires too much private capital to insure the – inherently systemic – credit risk of all conforming mortgages in MBS, there may be an important role for the government here....
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5 A substantial portion $173 billion was issued by these...

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