Yves Smith at Naked Capitalism has a fascinating post about the GSEs and private mortgage insurance. The short of it is that the GSEs don't seem to be making claims on PMI policies despite being the loss payees. The reason why is that if the GSEs made claims on the PMIs, it would quickly render all of the PMIs not just insolvent, but illiquid (which is the real kiss of death). And if the PMIs went under, then the GSEs would have to take huge write-downs on all of the still performing loans with PMI insurance. Chris Whalen estiamtes that in order to avoid perhaps $100B plus in write-downs, the GSEs are forgoing several billion in PMI claims. If this is the case, it shows what a farce GSE regulation by FHFA is.
There's a further twist, however, that Yves post didn't capture. A lot of PMI is reinsured. And guess who does about half of PMI reinsurance? The captive reinsurance affiliates of the large banks.
While most large banks have reinsurance capitves, the captives of the big 4 banks get about 1/3 of all PMI reinsurance premiums, which probably translates to something like 1/3 of the exposure. Just to list the biggest, that's Balboa Reinsurance (Countrywide/BoA); Bank of America Reinsurance (BoA); Cross Country Insurance (Chase); North Star Mortgage Guaranty Reinsurance (Wells Fargo). I haven't figured out the extent of this exposure, as not all PMI is reinsured, and not all reinsurance is first-loss position, but there is definitely some bank group skin on the line with PMI.
What this all means is that if the GSEs are forbearing in making claims on their PMI policies, it not only hides the GSEs' losses. It also means we're seeing another quiet bailout of the banks.
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In case you're interested in why banks' reinsurance captives are reinsuring PMI, it's a kickback game. The lender, not the homeowner picks the PMI carrier because they all charge the same rates and the homeowner is indifferent. The lender selects the PMI carrier based on the amount of business the PMI firm will cede to the lender's captive reinsurance subsidiary. And therein lies a regulatory capital game, as captive reinsurers aren't required to hold much regulatory capital at all, as there is jurisdictional competition for charters. The biggest US chartering jurisdiction for captive insurance companies in Vermont (!) and looking at Vermont's captive insurance law, I don't see any regulatory capital requirements beyond a de minimis initial capitalization that isn't enough to buy a house in parts of DC.
Comments
7 responses to “The GSEs, PMIs, and the Banks”
Great post. My question is what allows the GSEs(if we can still call them that) to avoid making claims? Aren’t there fiduciary obligations they are failing? Congress needs to investigate the dealings of the GSEs, and I suspect jail time will result.
I can’t help but wonder how long we will continue to prop up these insolvent TBTFs.
Hmm… pmi reinsurance… Could this be at least partially why The PMI Group, MGIC and Radian are tanking?
Professor, any thoughts as to why it was “fashionable” or more likely more profitable for the pmi insurers to own mortgage servicers up until roughly 2006 or so?
GSEs should not go for claims over PMI because it will be great loss. Probably that is the reason why things are going like that.
You may have seen this already since I posted it on Yves blog re the kickback scheme Countrywide seems to have conceded your point.
Here’s the BBG post from last week:
http://www.bloomberg.com/news/2011-03-18/countrywide-wins-preliminary-approval-of-34-million-settlement.html
And some more detailed background on the case:
NOVEMBER 5, 2009 – THIRD CIRCUIT ALLOWS HOMEBUYERS TO SUE FOR KICKBACKS EVEN IF THEY DID NOT PAY MORE – When a class of Pennsylvania homebuyers sued Countrywide Mortgage for allegedly violating the Real Estate Settlement Procedures Act (“RESPA”) for setting up a captive reinsurance program that amounted to a kickback scheme, the District Court in Philadelphia threw the case out because the plaintiffs did not allege that they had been overcharged. This proved to be short-lived respite, as the Third Circuit Court of Appeals has reinstated the case, finding that the statute intended to allow buyers to recover triple their expenses, even if they did not pay more than would have been the case without the improper activity Alston v. Countrywide Financial Corp., D.C. Civil. No. 07-cv-03508 (3d Cir. 2009).
Homebuyers who put less than 20% down had to purchase private mortgage insurance (“PMI”) in order to obtain financing from Countrywide. The lender referred buyers to one of a list of six insurers on a rotating basis. Those insurers were required to purchase reinsurance from a Countrywide affiliate, Balboa Reinsurance Co..
The suit claimed that this reinsurance purchase was really a kickback, citing Balboa’s receipt of $892 million in reinsurance premiums since 1999 without actually paying any claims. The plaintiffs claimed that this generally raised insurance rates because money was being paid that was not actually based on the taking of a risk, gave the PMI insurers no incentive to compete legitimately to attract customers through lowering the price or improving the coverage and by obfuscating any true disclosure of charges and interest.
Countrywide succesfully gained a dismissal in the trial court based on its argument that PMI rates are set by the state, and that the RESPA statute only allowed a private suit in the event of an overcharge. The District Court stated that the plaintiffs had paid “the only legal rate they could have paid for mortgage insurance in Pennsylvania.”
The Third Circuit disagreed and interpreted the statute to mean that a buyer could recover for three times any charge paid for the improper settlement service, regardless of whether the wrong led to an overcharge. The court also held that the non-monetary nature of the right infringed did not prevent the plaintiffs from having the “injury-in-fact” required for standing under Article III of the U.S. Constitution.
Finally, the court rejected Countrywide’s attempt to use the “filed rate doctrine” as a defense. Although it may not be possible to challenge a rate approved by the regulatory agency, here the plaintiffs were not challenging the rate — they were challenging the kickback scheme.
This decision obviously increases RESPA plaintiffs’ ability to use RESPA to challenge lenders’ activities. However, it is based on the language of this particular provision. In other RESPA provisions, the language of the statute limits recovery to actual damages.
Source: http://www.cwclaw.com/publications/alertDetail.aspx?id=339
Treble Damages. Imagine
Are there any actual facts to back up this interesting series of speculative posts?
Adam your stuff is always on point and shining the light on the Banks dirty secrets. When the legal storm is over the PMI companies will certainly taste their share of the mud pie the mortgage banking industry is currently feeding the american middle class homeowner. http://diligencegroupllc.net/
Thanks again!
American Homeowner
-AH
There has alway been something tasteless about money lenders, going
way back historically. Now I’m beginning to see why.