Private mortgage insurance is better, but could be ‘Too Big To Fail’

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central bankThe recent Central Bank announcement on their new mortgage rules was missing one instrument that has been bandied around recently – Mortgage Insurance. Now the Central Bank have issued a report that has so far concluded it’s not a good idea, particularly if it’s been run by the government and not a privately held financial institution.

What is Mortgage Insurance?

The proposed system could potentially mimic the Canadian system that has been in place since the 1950’s and reportedly kept their mortgage and property market in a fairly steady condition for nearly 70 years.

The Irish Examiner reported on this late last year (Read: Canadian model ‘would give mortgage market credibility’) with a statement from Angel Mas, president and chief executive of Mortgage Insurance Europe at Genworth. Similar to the Irish market today, in the 1950s, the Canadian government was faced with a twin dilemma, it wanted a stable financial system as well as encouraging young people to take out mortgages.

“The emphasis at that time was low loan-to-value mortgages, which meant that a huge cohort of young people were excluded from the property market.

As a way of getting around this, the Canadian government came up with the idea of mortgage insurance. If a bank wanted to issue a high loan to value mortgage of between 90%-95% of the asking price, then the bank would have to take out mortgage insurance to protect itself against the risk of default.”

As the insurance companies were the first in line to take any losses, they acted as an extra level of credit check to ensure only creditworthy buyers were accepted by the mortgage banks. It also spread the risk that is currently only held by a single mortgage bank, to a second financial institution, but for a lesser percentage of the value and not secured directly to the asset.

It also presents an opportunity for a county’s Central Bank to control mortgage lending without more heavy-handed economic levers, such as interest rate changes – something that is outside of the Irish Central Bank’s control anyway. The Bank could level restrictions on the lending or term length of the insurance scheme to take the heat out of a rampant property market.

Who would run it?

The Canadian system is run completely by private companies, but regulated just like any other financial institution.

“Three mortgage insurers compete for the business there – state-owned Canada Housing and Mortgage Corp and private operators Genworth and Canada Guaranty. They all charge banks a fee for the insurance, which gets passed on to borrowers.”

Bank of ireland RTEAs private entities this should encourage the system to be competitive and keep costs down, albeit the cost will get passed on to the consumer, it will at least allow buyers to get on the property ladder without a 20% deposit.

More here on how it would work: What is a mortgage guarantee scheme and how will it work? – The Irish Independent

However, seemingly the Central Bank has been considering running the system themselves. In a state-backed paper released yesterday (see The Indo for more details) the Central Bank concludes that a state-run scheme could damage the property market further. The Government would be left footing any losses and would be directly on the hook for large payouts if the market tanked again and there was a mass of mortgage defaults.

Benefits of a privately run scheme

Naturally the answer is a private company run scheme. I can’t see why the Central Bank were even considering this being a state-run system. It would only be another administrative nightmare – just look at the Irish Water fiasco – that will cost the state and taxpayer millions.

irish waterLet the big insurance companies compete to get into this lucrative business, at no cost to the government, and the risk is kept separate from the state as it should be.

However, despite the attraction of this scheme, the risk is never fully excluded in the the case of another catastrophic market crash. Heaven forbid we go through this again – but with the Irish cycle of things it’s not doubt a possibility in another 10 or 20 years – if we have a national insurance scheme tied up in thousands of bad mortgages there is risk of these private companies failing and looking for a bail out from the state again.

fannie maeWe saw this in the USA with the likes of Fanny Mae and Freddy Mac – national mortgage lending companies that, although private, became too big to fail and had to be bailed out by the government to keep the nation afloat.

Similarly it was sub-prime mortgage lending insurance that brought down massive insurer AIG.

We hope we’ve learnt from the mistakes we made this time around but in the exuberance of a rapidly rising market all things can be forgotten again. We don’t want the banks and a raft of insurance companies coming begging for a bail out.

The insurance scheme sounds like a good idea if we need to help first time buyers out, but it doesn’t completely replace the risk. For now the 80% limit – with concessions for buyers under €220,000 – does seem like the most prudent move but does consign frustrated buyers to more years of saving and renting.