Wednesday, February 16, 2011

The Other Mortgage Bailout

I'm ashamed I missed this one: We're already backstopping another mortgage bailout.

I've written before about my opposition to various schemes that force all taxpayers to take on catastrophic risks of loss that only benefit people who live in high risk areas, (like a plan to let the national flood insurance program practically give away hurricane insurance, or another great idea to force all of us to take on earthquake and hurricane risk.)

A recent report by Aon Benfield, one of the largest insurance brokers quantifies the earthquake risk Fannie Mae and Freddie Mac take.  That's right, neither agency ever required borrowers to have earthquake insurance.  That means all those mortgages in California, guaranteed by the two agencies, would be covered after the Big One, without even the indignity of the governor having to beg for a bailout!

How much is at stake?  Insurance companies typically look at a one in 250 year loss as an extreme (but possible) measure of risk.  Aon pegs the loss to Fannie and Freddie in a 1 in 250 quake at $33 billion.  That's right: Fannie and Freddie stand to lose $33 billion in an earthquake--not counting any credit losses! 

For fun, let's put that in the context of Fannie and Freddie three years ago.  (Yes, I'm assuming their quake exposure hasn't really changed in three years.)  At year end 2007, Fannie Mae had $44 billion of equity. Freddie Mac had $26.7 billion.  So, it's probably not far off that the combined entities had only about 2x the capital that they could have lost in a single, major earthquake.

Again, according to Aon Benfield, (not just me!) a reasonable commercial insurance company doesn't risk more than a 20% loss in book value in a 1:250 event.  So, the mortgage giants were taking risk as if they were a combined $168 billion book value insurer of earthquake risk, when they had less than half.

I know, like we need another reason to declare Fannie and Freddie insane exercises in risk taking...

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