Eyes Wide Shut? The Moral Hazard of Mortgage Insurers During the Housing Boom

69 Pages Posted: 1 Aug 2018

See all articles by Neil Bhutta

Neil Bhutta

Board of Governors of the Federal Reserve System

Benjamin J. Keys

The Wharton School - University of Pennsylvania, Real Estate Department

Date Written: July 2018

Abstract

In the U.S. mortgage market, private mortgage insurance (PMI) is mandated for high-leverage mortgages purchased by Fannie Mae and Freddie Mac to serve as a private market check on GSE risk-taking. However, we document that PMI firms dramatically expanded insurance on high-risk mortgages at the tail-end of the housing boom, contradicting the industry's own research regarding house price risk. Using three detailed sources of mortgage and insurance data, we examine PMI application denial rates, default rates on PMI-backed loans, and growth rates of high-leverage lending around the GSE conforming loan limit, along with information extracted from company, industry and regulatory filings and reports. We conclude that PMI behavior during the housing boom in part reflects a "moral hazard" incentive inherent to insurance companies in general to underprice risk and be undercapitalized. Our results suggest that rather than providing discipline, private mortgage insurers facilitated GSE risk-taking.

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Suggested Citation

Bhutta, Neil and Keys, Benjamin J., Eyes Wide Shut? The Moral Hazard of Mortgage Insurers During the Housing Boom (July 2018). NBER Working Paper No. w24844. Available at SSRN: https://ssrn.com/abstract=3218074

Neil Bhutta (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Benjamin J. Keys

The Wharton School - University of Pennsylvania, Real Estate Department ( email )

Philadelphia, PA 19104-6330
United States

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