Fannie Mae, Freddie Mac, and Earthquake Insurance for Mortgages

Could taxpayers be on the hook for yet another bailout? Representative Sean Duffy and Senator Tim Scott asked the Federal Home Finance Agency to provide information on the exposure of earthquake damage losses facing Fannie Mae and Freddie Mac GSEs (government sponsored enterprises).  The GSEs do not currently oblige mortgage borrowers to insure the mortgages against earthquake damage to structures.  In the event of any serious earthquake, structures may be damaged beyond repair, or beyond the owner’s financial ability repay the mortgage loan on the devastated structures.

The lawmakers’ question is relevant because loans from the GSEs are backed by the federal government, and it is prudent for the GSEs to insulate themselves from the loss of assets to the extent reasonable.

To quantify the extent of GSEs exposure, R Street estimated that the GSEs are owed $355.71 billion of unpaid principal for mortgages in the 249 most earthquake-prone US counties.  The U.S. Treasury owns $200 billion in GSEs’ senior preferred stock, giving taxpayers a large stake in the viability of the GSEs.

The top two concentrations for the highest risk of earthquakes and associated property damage are in California and Oklahoma.  However, only 13% of California homes are covered by earthquake insurance.  Using assumptions on the portion of principal attributable to structure value and surveys of earthquake insurance take up, R Street estimated the uninsured earthquake-exposed collateral held by the GSEs at a whopping  $205 billion in 2016.

The entire $205 billion is unlikely to evaporate due to earthquakes in any given year, but in 1994, the Northridge quake caused $13 to $44 billion in damages, or as much as 6% to 22% of the GSE mortgage portfolio, if all the damages were in GSE-mortgaged dwellings.  The GSEs face a material risk on our behalf.

The GSEs have several ways of removing the earthquake risk currently in their portfolio.  First, they could require mortgage originators to include a premium for earthquake insurance in regions where that is appropriate.  Secondly, if homeowners already have the right combination of seismic mitigation in their home or have earthquake insurance, they could be exempted from the mortgage originator fee.

Insurers do not always offer earthquake coverage. When homeowner insurers were required to offer earthquake insurance, some dropped out of the homeowner casualty insurance market.  GSEs could use insurers or reinsurers to backstop the losses, and have monthly payments included with other escrow components in mortgages.

There are options for GSEs.

What the GSEs should not do is sit on their hands.  Ignoring the risk to taxpayers is unacceptable.

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