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

Neil Bhutta and Benjamin Keys

No 24844, NBER Working Papers from National Bureau of Economic Research, Inc

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.

JEL-codes: G21 G22 L10 L14 (search for similar items in EconPapers)
Date: 2018-07
New Economics Papers: this item is included in nep-ias, nep-rmg and nep-ure
Note: CF IO PE
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Citations: View citations in EconPapers (3)

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