Banking brief: Private underwriting of riskier mortgages can benefit taxpayers

“Isn't this what got us in trouble in the first place?” That was the first reader comment following a CNN/Money web article concerning a recent shift by government sponsored entities (GSEs), who buy most mortgages from lenders, to accept down payments as low as 3%. The previous minimum was 5%.

In an era when banks are forced to hold more capital, the GSEs, which became insolvent during the financial crisis and needed a substantial infusion of capital to remain operational, have cut the minimum down payment for homebuyers.

This policy change enacted by the Federal Housing Finance Agency (FHFA) which regulates the GSEs, and by extension, influences trillions of dollars in mortgage exposure to American taxpayers, is a worrisome development. Defenders of the FHFA actions have pointed out to critics that the change still protects taxpayers by requiring private mortgage insurance and it applies only to issuance of fixed rate loans.

Fixed rate requirement

And to be fair, the fixed rate requirement is a good mechanism to manage taxpayer risk. Many will recall that waves of defaults occurred in 2007-2008 after in-over-their-heads borrowers witnessed mortgage payment increases on adjustable rate loans that reset at various interest rates.

Private mortgage insurance requirement

The private mortgage insurance attribute of the plan may offer less comfort to critics. In a related development, President Obama recently directed the Federal Housing Authority (FHA) to decrease the premiums it collects for FHA mortgage insurance. (The FHA is an agency of the federal government that insures private loans issued for new and existing homes). Like the GSEs, the FHA’s mortgage insurance fund required a taxpayer-funded lifeline in 2013, after unprecedented default volumes.

Private sector alternatives

Clearly, the intention is to lower the cost of a conventional mortgage for lower income homebuyers. And according to HUD, the lower mortgage insurance premium rates alone will create 250,000 new first-time homebuyers. Private sector alternatives to an expansion of the federal government’s domain in the housing markets are beneficial to all Americans because they mitigate the size of public (i.e., taxpayer) backstopped asset bubbles. We recently wrote about a program responsive to low-income homebuyers in the Minneapolis/St. Paul area. Such programs are proof positive that public-private partnerships can work when they are funded privately by institutions and accredited investors. Similar programs ought to be fostered and nurtured as viable options to the open spigot of taxpayer-funded mortgage credit and insurance now in place.