A Re-Examination of Federal Mortgage Rate Insurance

Abstract

In a recent paper in The Journal of Money, Credit and Banking,' Kaufman argued for the creation of a Federal Mortgage Rate Insurance Company to reimburse losses which might arise from a discrepancy between short-term deposit rates and long-term mortgage rates. A difference between the two may arise from the asset/liability maturity imbalance characteristic of thrift institutions since they borrow money from short-term deposits and lend it in long-term mortgages. The purpose of this note is to bring Kaufman's argument to the attention of the readers of this Journal since it may be unfamiliar. An additional purpose is to demonstrate that Kaufman's illustration of maturity intermediation practices by the thrift institution and its desire to have profits balance losses omitted the repayment likelihood and the potential ability of the thrift to adjust interest rates on assumption.2 Also, possible alternatives to federal mortgage insurance are suggested. According to Kaufman, a thrift institution could buy this coverage if the consumer desired a fixed-rate mortgage (FRM), and the consumer could buy coverage if the institution gave him a variable-rate mortgage (VRM). In Graph 1, Kaufman argued that given expected interest rates on deposits AC, a thrift institution would set a mortgage rate BD causing equal profit and loss triangles, ABO and OCD, respectively, over the life of the mortgage. Inserting a weighted life expectancy3 of a new mortgage which includes prepayment statistics4 changes the relationship between profits and losses significantly. Recent estimates by Kinkade5 and Chu, Kalish, and Thyger-