A private securities market set up exclusively for prime mortgages can be developed and attract investors as Fannie Mae and Freddie Mac are phased out, according to three American Enterprise Institute fellows.

The AEI plan, unveiled Thursday morning in Washington, calls for securitizing strictly defined prime mortgages backed by private mortgage insurance. Other mortgages could not be placed in public securities that are registered with Securities and Exchange Commission.

The authors of the plan — Peter Wallison, Alex Pollock and Edward Pinto, three frequent critics of the GSEs — expect that MI companies would be quickly re-capitalized if such a plan were adopted by Congress.  And the creation of the other government-backed secondary market entities to replace the GSEs would not be necessary.

The plan is based on "mortgage quality" and the creation of a "robust housing investment market without a government guarantee," Wallison said Thursday morning.

Only mortgages with a minimum downpayment of 10% and 660 credit score could be securitized. Mortgage insurance is needed to cover mortgages with loan-to-value ratios higher than 60%.

"Research shows that loans with an LTV of 60% or less sustain virtually no losses," according to the AEI paper: Taking the Government out of Housing Finance

Second mortgages or other liens would not be permitted without approval of the mortgage holder and insurer.

After consulting securities experts, the authors estimate the interest rate on these high quality 30-year mortgages would be only 25 basis points to 40 bps higher than GSE rate today.

The AEI paper also lays out a five-year plan for phasing Fannie and Freddie and  allows the GSE (to be announced) TBA market to continue to be available for hedging.

"As the private MBS market becomes larger and more liquid, a non-GSE TBA market for these securities will develop," the paper says.

For a copy of the white paper, please click think link.

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