They envision replacing the gses with two or three

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They envision replacing the GSEs with two or three “mortgage credit guarantor entities” (MCGEs) that would guarantee timely payment of principal and interest on “core” mortgage loans: presumably, defined as conventional conforming single- family and multi-family mortgages. These MCGEs would be new, private, mono-line insurers that would own the mortgage loans and issue MBS against them. They would be financed by debt and equity and not carry any government guarantee. The MBS that they issue would be guaranteed by the full faith and credit of the U.S. government. The federal insurance fund (a role that could be assigned to Ginnie Mae) would receive a risk-based insurance fee from the MCGEs in return for this credit risk insurance. A recent study by economists of the Federal Reserve Bank of New York also proposes a hybrid solution. 57 This proposal differs from ours in that the lenders would bear the first losses, and the government would bear only losses in extreme events (although it is not clear what exactly In it, the mortgage originators would form a private lender cooperative in order to securitize conforming mortgages. The cooperative would share the profits and the “normal losses” in proportion to the members’ origination share. The losses arising from “tail risks” -- rare events such as the one that we witnessed in 2008-2009 -- would be borne by the government. In return for bearing the tail risk, the government would charge the cooperative a fee.
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120 constitutes an extreme event). This is similar in spirit to the aforementioned TRIA. Our proposal has a parallel loss-sharing arrangement. In an extreme housing crisis, the cooperative would lose all of its capital and would likely need to be bailed out by the government (unless it had a 100% capitalization). In that sense, it is like a private sector GSE. Our proposal has investors in MBS that will potentially lose, say, 25% of their investment if the private insurer that they select goes bust and there is no recovery. This incentivizes the investor to do due diligence and the private sector insurer to adhere to solid origination standards. Our proposal also has the advantage of firmly establishing a market price for the default risk, while it is not so obvious how the government would establish and enforce a fair tail risk price. Market prices will in theory not crowd out other private sector solutions, allowing for greater financial innovation. 8.3 Nonconforming Mortgages The above proposals -- whether nationalization, privatization or our hybrid private- public partnership -- deal with conforming mortgages. But there are a substantial number of mortgages that are either underwater or have mark-to-market loan-to-value (LTV) ratios above the conforming limit of 80%. For example, as of the end of 2009, there were 47 million homeowners with a mortgage. A staggering 24 million (or 51%) had less than 25% equity, with 11.3 million of these having LTVs greater than 100% and another 2.3 million approaching negative equity.
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