Why didn’t the private mortgage insurance avert the current banking and credit crisis?

BY busadmin  August 4, 2008 at 3:53 PM EDT

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Question/Comment: Not long ago, writing mortgages required private mortgage insurance (PMI) if the borrower’s equity in the property was below a certain percent of market level. Usually, PMI could be discontinued when the borrower’s equity in the property rose above that market level. Presumably, PMI was required for subprime borrowers. In event of default, PMI would protect the lender to some extent and to whomever the mortgage was wholesaled.

Why didn’t the PMI avert the current banking and credit crisis? What greater justification for PMI could there be than as a condition of making a loan to a subprime borrower?

Paul Solman: I think there are two answers to your question. First, many loans skirted the insurance requirement via second mortgages, and it’s only the first mortgage that must insured if you put down less than 80 percent. Second, the private insurers are deemed to be in serious trouble. Witness the fact that their stock is plummeting.

I also sent your question on to someone who actually knows this stuff, Nic Retsinas, director of Harvard University’s Joint Center for Housing Studies, and occasional NewsHour guest.

His response: “I would only add that private mortgage insurance is commonly associated (i.e., required in many cases) with the origination of prime loans sold to or securitized by the [government-sponsored enterprises] (Fannie and Freddie). Most subprime loans (especially the more toxic products) were packaged through private issuers and did not carry (or require) mortgage insurance.”