... One of the actors in the subprime/Alt A market was private mortgage insurers. For those of you lucky enough to be unfamiliar with this concept, PMI is insurance paid for by the borrower for the benefit of the lender. It is used to insure the property value on highly levered transactions. Lenders were quite happy to lend up to 80% of appraised value based on semi-decent income; it was considered unlikely before the crisis that home values would fall all that much in a specific geography even in a recession. But for the amount in excess of 80%, the lender wanted extra protection. In steps the PMI insurer. If the borrower wants to make only a 10% downpayment, he would need to get a PMI policy to insure against the possibility that the value of his house might fall below the 90% he had borrowed against it, down to the 80% risk that the lender was prepared to shoulder.

Given the prevalence of PMI insurance, their thin capitalization, and the big wipeout in home values, they should be as dead as the monolines. But they aren’t. That’s because they are engaging in insurance fraud, namely, refusing to pay out legitimate claims.

And perversely, as Whalen tells us, they are getting quite a bit of help from Fannie and Freddie not making claim at all. Why not? Well, if the GSEs did put in claims, the PMIs would quickly go bust and Fannie and Freddie would report losses. So the failure to put in claims is yet another variant of “extend and pretend”. But in this case, there’s good reason to believe the numbers are very large ...