How to tap AI’s potential while avoiding its pitfalls

Banks’ climate pledges don’t add up to change, research finds

The impact of misleading headlines on Facebook

Ideas Made to Matter


An analysis of Fannie Mae's Credit Risk Transfer program


A new study from an MIT Sloan strategic management expert suggests taxpayers might not have to bear the brunt of another housing crisis bailout — if government-sponsored mortgage companies make some changes. 

MIT Sloan senior lecturer Robert Pozen, and Clayton Pfannenstiel, MBA ’18, recently analyzed Fannie Mae’s credit risk transfer program, and while they applaud the work for “expand[ing] the investor base for CRTs by adopting a better tax structure … [they] believe that Fannie Mae should increase the amount of credit risk it transfers to CRT investors; and the guarantee fees charged by Fannie Mae to mortgage originators should be based on the implied guarantee fee paid to CRT investors.”

According to the study — which was published by the Brookings Institution — the program has issued more than $30 billion of credit risk transfers and more than $1 trillion of “unpaid principal balance,” to the private sector, in the roughly five years it’s been around.

Pozen said that ideally institutions like Fannie and Freddie would continue to play a big role in the housing market, but the government would not be 100 percent at risk for any future housing crisis.

Here’s how the program works: Someone buys a home, and obtains a mortgage from a bank. The bank then turns and sells this home mortgage to Fannie Mae, which creates a pool of similar mortgages and sells interests in the pool to private investors as mortgage backed securities. 

“One of the most important attractions of these securities is that they are totally guaranteed against default by Fannie Mae, which is backed by the federal government,” Pozen said. “But to reduce its risk on credit defaults, Fannie Mae in turn lays off most of that guarantee to private investors through credit risk transfer securities.”

Losses are doled out to various sections — called tranches — depending on who is the investor. The losses absorbed by these tranches range from the half a percent, to 4 percent. At that point, Fannie Mae absorbs the losses.

Pozen and Pfannenstiel propose Fannie Mae increase that 4 percent mortgage risk limit to 5 percent.

“They think it’s too good a deal for investors, but it’s too good a deal until it’s not,” Pozen said of Fannie Mae. “We’re saying that Fannie Mae ought to be more conservative — adding a margin of error relative to how its portfolios would have performed in the 2008 financial crisis.”

Not perfect, but creative
Pozen did applaud the guarantee fee charged by Fannie Mae to the banks and brokers, because this fee is currently determined by the government. But the CRT program allows those fees to be set by what the private sector would say is a reasonable amount, Pozen said.

Having private sector buy in is also good because there will be future problems, including mortgage defaults, Pozen said.

“They’ll police it, they won’t let these [home buyers] go down to 1 percent down payments,” Pozen said.

Ideally, Pozen said, institutions like Fannie Mae would play a big role in the market, while the government would not be 100 percent at risk for every future housing crisis.

“Basically the government is on the hook for defaults,” Pozen said. “Of course now no one is defaulting, but it will happen.”

The decade-long stalemate on Capitol Hill of how to federally support the housing market while appeasing taxpayers hasn’t produced much progress, Pozen said. But the credit risk transfer program “is the first good idea I’ve seen in a long time.”

“These guys came up with something creative, which isn’t perfect, but it’s sort of like, it’s keeping the government support of the mortgage market, while getting the taxpayer off the hook, to a significant degree,” Pozen said. “So it’s definitely a big step forward. Of course, it should be refined. People ought to embrace this.”

For more info Meredith Somers News Writer (617) 715-4216