55 4 note that the insurance company might be a

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55 4. Note that the insurance company might be a monoline, but could also be a subsidiary within a larger organization. If the latter, the subsidiary would have to be independently capitalized and ring-fenced against losses at the parent company. In other words, the insurance subsidiary would be treated similarly to other insurance units, such as life insurance subsidiaries, that are housed within larger organizational forms, and subject to its own resolution authority. This way, market discipline is restored to an extent because both creditors of the insurance company and MBS investors are now liable for a fraction of the MBS losses. 5. Capital requirement rules for investors in the MBS that are issued under the public/private partnership would need to be carefully designed in order to avoid a new round of regulatory arbitrage. Leading up to the financial crisis, GSE debt and guaranteed MBS were charged lower capital requirements. As described in Chapter 1, this led to a vicious circle of (i) financial institutions’ originating GSE- conforming mortgages, (ii) financial institutions’ then providing debt financing for the GSEs to purchase these same mortgages and/or issue MBS, and (iii) financial institutions’ then further levering up on these MBS. The result was an increasing interconnection between the banking sector and the GSEs, and greater leverage all around. Specifically, we propose that the MBS under the private- public partnership would get risk-weights for capital that equal 75% of typical agency securities to reflect the government guarantee and 25% of the underlying rating (i.e., risk) of the mortgage insurance company.
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119 6. The GMRIC would be a boring government-run public utility with the sole purpose of passively co-insuring the credit risk on conforming (core) mortgages. It would explicitly be barred from holding any mortgage-related assets, but could hold only Treasuries, which keep their value during crises. It would have no say over the composition of borrowers (e.g., fraction of low-income borrowers), other than a strict adherence to the definition of a conforming (core) mortgage. It would be tightly regulated by the FHFA. The GMRIC would be fully accounted for on the government budget. Note that our hybrid solution is quite similar to what the Mortgage Bankers Association (MBA) has recently proposed. 56 It is not clear how the guarantee fee that the government receives would be set in the MBA proposal. As mentioned above, we view the most important element of a private-public partnership to be the market pricing of all of the guarantees. This is a substantial problem of the MBA proposal in our view. We also fear that only “two or three” MCGEs, which are subject to loan-level credit risk and would still be allowed to hold some mortgages in portfolio, would create new systemically risky institutions, which would need to be bailed out in the event of a major housing crisis.
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