Discussion: Modeling the Budgetary Costs of FHA’s Single Family Mortgage Insurance Laurie Goodman, Center Director Housing Finance Policy Center Urban Institute MIT Center for Finance and Policy Inaugural Conference September 12-13, 2014 Cambridge, MA 1

Discussion Modeling the Budgetary Costs of FHA’s Single Family Mortgage Insurance Forecast cash flows on FHA mortgages to calculate subsidy rates on loan guarantees – model prepayment and defaults – model loss given default – simulate future results using 1000 paths; variables include home prices, interest rates and unemployment Estimate appropriate subsidy rate on a fair value calculation – use OAS to capture discount rate on securities with government guarantee – credit risk premium is derived from partial insurance coverage provided by private mortgage insurers (or PMI premiums + Fannie/Freddie fees) 2

Quibbles Greater transparency on actual and estimated cash flows – Would allow researchers to experiment with different assumptions about discounting, other changes. At minimum, providing a duration measure for remaining balance by vintage year would be helpful. Loss-given-default results were not transparent and may not be indicative of current period – 85% of liquidated loans had mark-to-market LTVs of , reflecting data ending in MSA level mark-to-market was used, with no accounting for price tier. No summary statistics were presented. More transparency on calculations of fair value subsidy rates 3

Larger Comments Models used to estimate prepayments, defaults, and loss given default were estimated over long period in which parameters are unstable – All errors accumulate in one direction; loans made in later years will have longer average durations than loans made in earlier years Fair value subsidy rate calculation raises concerns – OASs are much higher than those calculated by Wall Street firms; an explanation would be in order 4

Huge structural changes in past two decades Result: Shifts in prepayment and default curves all point to mortgage loans remaining outstanding for longer periods of time Homeowner mobility is down The prepayment S-curve is flatter, as the costs of origination are up sharply Foreclosure timelines have extended, modifications are a permanent part of the new loss mitigation landscape FHA mortgages are assumable, which will prove important in a rising rate environment Additional analysis: The careful estimation of the prepayment/default models give a false sense of precision. It is important to recognize structural changes in the market, which could be done within the confines of their analysis. Policy implications: These structural changes have important implications for FHA pricing, as the profitability of new FHA guarantees would rise sharply. 5

Homeowner mobility has been declining for decades 6

Originators processing fewer loans per month, resulting in higher cost of origination Applications per retail underwriter per month Source: Mortgage Bankers Association, Peer Group Program conducted by MBA and STRATMOR Group. 7

Mortgages are less refinanceable 8

Foreclosure timelines have extended (PLS only) AS-MMM0814 Liquidation lag (months to liquidate)% of Liquidations Greater than 18/24 Months DQ (% of Balance) Source: Amherst Securities analysis of CoreLogic and 1010Data.

10 Modifications now a permanent part of loss mitigation landscape

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Thoughts on fair value subsidy rate Calculated as present value (PV) of the guaranteed loan less present value of the non-guaranteed loan – PV of the guaranteed loan is calculated as MBS cash flows, discounted by Treasury notes of comparable maturity + the option adjusted spread. – PV of the non-guaranteed loan is calculated as cash flows of a portfolio of non-guaranteed loans discounted at the Treasury note rate + the OAS + the market risk premium. The OAS in this paper is far higher than is calculated by any Wall Street Firm, and merits an explanation or at least an acknowledgement 12

OAS and Zero Volatility OAS on GNMA Securities 13