An industry redefining itself.

Today, large portions of the housing finance system are operating on the financial equivalent of life support, kept alive by a variety of federal agencies. Whether this is a temporary or a permanent condition will depend in part on the steps the Obama administration takes to support, resuscitate and restructure the financial markets.

The challenge, as I see it, is doing what is necessary to recapitalize and restore confidence in the system, without destroying incentives for innovation or discarding the system's key elements that have worked for generations of Americans. Clearly, the failures of the past argue for better risk-management practices and stronger federal oversight, particularly for those participants in the housing finance system that were virtually unregulated.

New rules must be put in place to monitor and better manage systemic risk within the lending, banking and securities industries. Likewise, commonly held assumptions must be questioned, accepted practices scrutinized and new, stronger measures installed throughout the system.

However, the argument for an expanded federal role in the U.S. mortgage markets should not preclude the private sector from playing a robust and leading role in mortgage finance. If the rebuilding plan leaves no role for private capital and for non-governmental solutions, then government and taxpayers will be forced to bear the entire risk of our housing finance system.

As we are looking for new and better ways to help Americans buy homes, help lenders replenish capital and investors regain confidence in mortgage-backed securities (MBS), we need to remember that not everything is broken and, to use a well-worn cliche, we should not throw the baby out with the bathwater.

Even in today's challenging environment, private mortgage insurers continue to be key partners with the lending industry and the government-sponsored enterprises (GSEs) in helping to manage risk, prevent foreclosures and do exactly what we were set up to do--pay claims. In fact, the private mortgage insurance industry has paid the GSEs and other investors in excess of $15 billion in loss settlements over the past two and a half years alone. Additionally, members of the Washington, D.C.-based Mortgage Insurance Companies of America (MICA) are adequately capitalized to meet their expected claims obligations for those loans that do result in foreclosure.

Just as important, mortgage insurance (MI) companies are working with the GSEs and lenders to prevent foreclosures. The industry supports streamlined modification programs and other initiatives designed to keep borrowers in their homes, and PMI has a history of working with borrowers as part of our overall loss-mitigation efforts. In 2008, PMI Mortgage Insurance Co. was able to help more than 18,000 families keep their homes, and I'm sure our competitors have similar success stories.

This is why James Lockhart, director of the Federal Housing Finance Agency (FHFA), has gone on record saying that "Fannie Mae and Freddie Mac, as well as the nation's homeowners, need the continued assistance of mortgage insurers to provide market stability, safety and soundness for the housing finance system."

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Should the restructured mortgage industry continue to rely on private credit enhancement? Obviously, my view is biased on this subject. But beyond the billions of dollars the MI companies have paid to protect the GSEs and other mortgage investors, the other consideration is: What are the alternatives?

As an industry, we are still dealing with the legacy of 80-10-10 piggyback schemes, derivatives and other financial structures that were used as an alternative to private mortgage insurance. These risk-transfer structures have largely vanished from the market because the participants did not fully understand the associated risks. Furthermore, the participants were poorly regulated, undercapitalized and, unlike mortgage insurers, had no long-term commitment to the housing finance industry.

Although there is significant stress on all sides of the mortgage industry, including mortgage insurers, the fundamental strength of our business model in protecting policyholders cannot be denied. Mortgage insurers' time-tested business model, supported by a foundation of regulatory capital, reserving mandates and rigorous third-party scrutiny, is serving lenders and the GSEs well.

Despite limited resources, the Federal Housing Administration (FHA) has served as a major backstop to the housing industry during this time of unprecedented turmoil. FHA should and will continue to play an important role in a restructured housing finance system. But without a vibrant private mortgage insurance industry, FHA would have to bear the entire risk of both the low-down-payment and non-prime market segments.

Historically, mortgage insurance companies have covered between 10 percent and 16 percent of the new origination market. Assuming just the lowest penetration rate--say, 10 percent--that would mean that FHA and American taxpayers would need to assume significant levels in additional risk that otherwise would have been assumed by the private markets. This is in addition to the larger risk-in-force that FHA will inevitably be carrying due to higher market share and significantly higher loan limits.

Obviously, rebuilding the mortgage finance system will require more than just a proven credit-enhancement mechanism. The role of the GSEs, securitization, automated underwriting and appropriate structure of the mortgage origination supply chain will all need to be re-examined--not only in terms of what went wrong, but also in terms of what went right for more than three decades.

There is a growing belief that the future of the housing finance industry will look more like the past: Products will be simpler, lenders more risk-conscious and borrowers once again underwritten using the four C's--credit, capacity, collateral and character. But the question remains: How far back should we go?

There has been significant innovation in the last 60 years, and as a nation, I do not believe we are ready to go back to the days of 20 percent down-payment requirements on conventional and jumbo loans, regional credit shortages and six-week turnaround times on mortgage decisions. We still will need proven credit enhancements for prime borrowers who do not have 20 percent down payments and do not fit within the FHA program.

Historically, the private sector has been a source of innovation that has quickened underwriting decisions, produced better monitoring of risk and reduced fraud. The future will require these same forces to rebuild. Whatever long-term structure the federal regulatory system for housing finance assumes, it is essential that it include a prominent and continued role for both private and public solutions. It may take more time and more restraint to preserve this balance, but it will be worth it if we get it right.

David H. Katkov is executive vice president and chief business officer of The PMI Group Inc., Walnut Creek, California He can be reached at [e-mail].