It’s time to abolish the FHFA

By Felix Salmon
February 26, 2013

Remember the force-placed insurance scandal, which first came to light back in 2010? Well, despite being addressed in Dodd-Frank, the problem is still there: loan servicers are buying massively overpriced home insurance on behalf of homeowners, and getting enormous kickbacks from the insurers — if they don’t own the insurers themselves. The victims, here, are usually the investors who own the mortgages in question — which means that the biggest victims of all are Fannie Mae and Freddie Mac.

Fannie alone has seen its hazard insurance costs rise from around $25 million a year before the financial crisis to $631 million in 2012. That’s real money, and so Fannie came up with a plan to save hundreds of millions of dollars. Rather than paying through the nose for the most expensive insurance the servicers could find, Fannie decided to buy the insurance itself.

Fannie ran this idea past its regulator, FHFA, on February 17, 2012, reports Jeff Horwitz in another one of his fantastic articles on this issue today. Back then, the FHFA had no objections. So Fannie put out an RFP, asking 12 insurers for their ideas. The results can be seen here: the winner was a proposal from Overby-Seawell Company, which proposed a system anybody could join.

OSC excelled at program design, Fannie concluded. It had also pulled off a coup by partnering with Zurich Insurance, a Swiss reinsurer with a $400 billion balance sheet, a superior A+ rating from insurance rating company AM Best and historical experience in the force-placed market.

Zurich stood ready to take on all of Fannie’s business if necessary, but under OSC’s model any qualified insurer could take a piece of the GSE’s business by joining a consortium of carriers willing to divide Fannie’s risk. Among the proposal’s attractions were “market driven pricing,” and “one entity fully accountable to Fannie Mae and servicers,” Fannie documents state.

Fannie put thought into preventing excessive market disruption as well, the documents show. Incumbent insurers willing to match Zurich’s prices would be permitted to retain existing business. If they didn’t, banks could still hire them to administer force-placed programs. Insurers were also welcome to join the Zurich consortium.

Fannie showed OSC’s proposal to the FHFA on May 9, and again faced no objections. The “final project recommendations” were then run by the regulator on September 28, as well as on follow-up calls on October 12 and October 22. Everything was in place: the only thing left was formal FHFA approval.

Which never arrived.

Instead, faced with lobbying from the American Bankers Association and others, the FHFA vetoed the whole plan on February 8; once the news was made public, shares in the largest force-placed insurer, Assurant, immediately surged. At this point, Fannie’s plan seems to be definitively dead — replaced with a group of committees whose objective isn’t obvious and which have every incentive to drag things out.

The result is that Fannie has seen at least $150 million of savings evaporate — and homeowners are going to wind up overpaying even more, for insurance their servicers have chosen for them.

So, what does the FHFA think it’s playing at, here? It’s not exactly being forthcoming on the subject: a spokeswoman said only that “FHFA will work with Fannie Mae, Freddie Mac and key stakeholders… to address issues associated with force placed insurance,” although the FHFA’s Meg Burns has said that the regulator has no timeframe and no particular idea what approach it’s going to take on these issues.

I’ve heard of regulators being captured by the organizations they’re supposed to be regulating — that happens all too frequently. But the situation at the FHFA seems to be even worse: it looks as though it has been captured by the banks which are extracting rents from the regulated organizations.

Indeed, it’s hard to think of a single good reason why the FHFA should exist at all. By all means regulate Fannie and Freddie — but give that job to the same regulators who are in charge of overseeing all the other major financial institutions in the country. The FHFA has been useless and obstructive pretty much from day one, and this latest decision only serves to underscore how counterproductive it’s being. If the Obama administration can’t get rid of its head, Ed DeMarco, maybe it should just abolish the entire thing.

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