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According to an unpublished paper provided to American Banker, the central bank officials are proposing to create a deposit insurance-like system for the secondary market.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. American Banker is a sister publication to National Mortgage News.
