WASHINGTON — While the call for the creation of a catastrophic insurance fund for mortgage-backed securities has been gaining ground in recent weeks, two leading Federal Reserve Board economists are poised to push the concept one step further, suggesting a backstop for all asset-backed securities.
According to an unpublished paper provided to American Banker, the central bank officials are proposing to create a deposit insurance-like system for the secondary market. The economists — Wayne Passmore and Diana Hancock, the associate director and deputy associate director, respectively, in the division of research and statistics at the Fed — argue that an explicit backstop of certain asset-backed securities could ensure the stability of the system in future financial crises and help eliminate the concept of "too big to fail" institutions.
"People who hold mortgage-backed securities or asset-backed securities are happy as long as they know there is no credit risk," Hancock said in a recent interview. "When they're really concerned that there is credit risk, they may run. That's not good for a securitization market."
To protect against such securitization runs, which can dry up credit availability, the two economists said an insurance fund should be created to cover catastrophic risks on a wide range of asset classes, including mortgages, credit cards and auto loans.
"We are arguing we should create an FDIC-like entity to explicitly price this form of guarantee," Passmore said in the same interview. "It will capture many of the benefits that have been associated with the GSEs, they will allow the government to accumulate an insurance fund, or reserves, to pay for supporting the fund up front. That's really the essence of why people want the government in the mortgage market. It defines well what the government's role will be."
The paper, which is due to be published in coming weeks, has been circulated over the past few months as a discussion draft, including at the Chicago Fed's conference in May. But it has yet to receive widespread attention.
When it is finally published, it will likely arrive at a critical juncture of the debate over the future of the government-sponsored enterprises. Leading policymakers have mostly remained silent about how they plan to revamp the structure of housing finance, but at a Treasury Department conference last week, several endorsed the creation of an insurance fund for MBS.
Under separate proposals from the Housing Policy Council and others, Fannie Mae and Freddie Mac would be replaced with privately capitalized, federally chartered companies that buy mortgages from the primary market and deliver them into a federally guaranteed mortgage-backed security.
The new companies would pay a risk-based fee used to establish an insurance fund, similar to that of the FDIC, which would cover catastrophic losses on MBS.
The Fed economists' view is different in some critical respects. For one, they appear to envision a government-run agency running the fund, either Fannie, Freddie, or a combination of the two. That entity's sole purpose would be limited to providing a guarantee and running an insurance fund. It could not sell its own unsecured debt or build a mortgage portfolio.
More important, the guarantee would not be confined to mortgages and could be expanded to include any asset-backed security to prevent disruptions in other securitization markets in a future crisis. "Issuers and investors want to believe that implicit guarantees extend to other asset classes so we want this authority to be able to expand the authority to other classes if needed," Passmore said. "If there is an implicit guarantee, it should be made explicit."
