paper about MBS

Mortgage default insurance would be offered through a

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Unformatted text preview: Mortgage default insurance would be offered through a new private-public partnership structure. The idea behind the structure is that the private sector provides insurance with the purpose of establishing a market price for the insurance. Since the amount of private capital available to provide such systemic insurance is likely to be limited, most of the insurance would be purchased from the government. Although some reinsurance schemes along these lines have been examined by the FDIC, most recently in 1993, and were dismissed based on the conclusion that this market is not feasible, there is reason to be more optimistic today. Financial markets, in general, have become much more sophisticated in how they develop niche markets. For example, motivated by the events of September 11, 2001, the Terrorism Risk Insurance Act (TRIA), first passed in November 2002, offers federal reinsurance for qualifying losses from a terrorist attack. TRIA is a good place to start and includes industry loss triggers and government coverage of excess losses. These features help minimize the insurance industry’s losses, yet also provide them with an incentive to monitor and reduce risks. While we believe that the insurance design would have to be somewhat different here, TRIA shows that co-insurance programs are not without precedent. 117 Specifically, in our private-public partnership, the securitizer would purchase a fraction of its insurance from a monoline insurance company and the rest from a newly formed government entity, which we will call the Government Mortgage Risk Insurance Corporation (GMRIC). As with terrorism risk insurance, the private insurance market would help to establish a market price for mortgage default risk. The newly formed GMRIC would charge a fee based on this market price. This would ensure that the government receives adequate compensation for the credit risk -- a key difference with the pre-crisis approach. The advantage of establishing a market price cannot be underestimated. While the public-private guarantee will ensure sufficient liquidity in the secondary market and lower mortgage rates, these rates will now reflect the true market and credit risk of the underlying mortgages. Investors will purchase MBS that reflect these rates and thus the price of the underlying mortgage insurance. Most important, because market prices will no longer be distorted, competing private markets will no longer be crowded out. Therefore, markets for MBS without guarantees will be free to develop. If enough liquidity can be sustained in these markets, investors will be able to move along the risk-return tradeoff curve, private capital markets will grow, and the government will become less involved in mortgage finance....
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Mortgage default insurance would be offered through a new...

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