LONG BEFORE NO-MONEY-DOWN

and interest-only loans, there was private mortgage insurance.

Private mortgage insurance was designed to promote home ownership by lowering the risk of lending to people who don't have enough cash for a full down payment. But today, the industry that was supposed to be a safety net during tough economic times is in its own tailspin.

Major mortgage insurers such as PMI Group, Radian and MGIC Investment each lost more than, or nearly, $1 billion last year. In turn, the already small stocks have shed some 80% to 90% of their value over the past 52 weeks. With credit losses yet to peak, Standard & Poor's expects few mortgage insurers to turn a profit from underwriting again before 2010.

The trajectory of these once-staid businesses gives another glimpse into just how the heady housing days turned into what's now a widespread credit contagion. While private mortgage insurers played a relatively small role during the bubble, they're paying a large price for it.

"We continue to recommend investors shy away from the mortgage insurance companies," Friedman Billings Ramsey analyst Steve Stelmach said in a research note on March 18.

Private mortgage insurance was theoretically created to prevent the painful credit losses that banks and investors are seeing today. In the past, borrowers who didn't have enough cash on hand for a full 20% down payment for a mortgage usually had to buy mortgage insurance, which insures against losses if the borrower defaults. Buyers usually have to make a down payment of at least 3% to 5% to qualify for PMI loans. Major investors in mortgages, namely Fannie Mae and Freddie Mac, which provide liquidity in the mortgage market by buying home loans, require insurance on loans with less than 20% equity.

During the bubble, however, PMI providers lost business as low interest rates made it easy to get cheap loans. A big source of competition came from so-called piggyback loans, where borrowers with no down payment took out one loan covering 80% of the mortgage, which didn't require PMI, and a second loan covering the rest, allowing them to essentially borrow a down payment.

Between 2003 and 2007, the percentage of first-time home buyers with no-money-down loans rose to 45% from 28%, according to the National Association of Realtors. Of first-time home buyers with down payments, the average amount they deposited fell to 2% from 6% of the purchase price of a home.

Private mortgage insurers, meanwhile, were losing business. In 2003, the industry wrote $376 billion in new insurance. Within three years, that number had fallen 40%, according to the Mortgage Insurance Companies of America, a trade group. Another indicator of the industry's financial health also showed signs of stress its "combined ratio," which is the percentage of insurance premium income that insurers have to pay out in claims and expenses, rose to 65% in 2006 from 48% in 2003.

"It was a very difficult environment for us to grow in," says Bill Horning, head of investor relations at PMI Group.

Still, investors pushed shares of mortgage insurers higher. PMI Group's stock rose 55% to trade at $47 by the end of 2006, from the start of 2003. Radian shares increased 40% to $54 and MGIC shares climbed 50% to $62.

To be sure, the companies were growing earnings and revenue despite the competition. Some analysts say mortgage insurers, whether by choice or due to financial pressure, loosened their underwriting to make up for business lost to piggyback loans. As long as real estate prices rose, performance was solid.

"If home prices had continued to rise the weaknesses in their underwriting, or setting of risk, would never have been revealed," says James Brender, a credit analyst at Standard & Poor's. "They definitely increased their risk profile and became more aggressive because they were losing market share."

One indicator of mortgage insurers' risk profile is their "risk in force," or the balance of insured loans multiplied by the insurance coverage. For PMI Group, loans with looser requirements and higher-than-average default rates like "Alt-A" loans made up a larger percentage of its risk in force over the years. Alt-A loans, which require fewer financial verifications than other loans, climbed to 23% of risk in force last year, up from 9% in 2003. Interest-only loans increased to 14% last year from essentially nothing in 2004 and 2003, according to PMI's latest annual report. Adjustable rate mortgages and "hybrid" loans, in which the interest rate is fixed for two years and floats thereafter, also took up larger shares of PMI's risk in force during the boom.

"Ultimately it's been poor underwriting without question, but declining home values has been a big driver as well," says Tom Abruzzo, a credit analyst at Fitch Ratings. "People are sitting on homes worth less than their mortgages and are just walking away from them. But if you weren't underwriting [during the boom] you weren't making money."

Mortgage insurers are also taking hits from their side investments. PMI Group's $915 million loss in 2007 included $776 million in losses from its FGIC financial guaranty business, in which it owns a 42% stake. FGIC is losing money on collateralized debt obligations that were backed by subprime mortgage-backed securities, an area of business FGIC entered into in 2005.

MGIC also had a large write-off of $466 million last year for its entire investment in C-Bass, which invested in the credit risk of subprime housing mortgages. C-Bass ended up not being able to meet margin calls from lenders once the subprime market imploded.

"Certainly there are a lot of would've, could've and should'ves," says Mike Zimmerman, head of investor relations at MGIC. "We're not saying we're victims. There were some things outside of our control, but not everything was." Zimmerman notes, though, that if MGIC had pulled back its underwriting when others were ramping up during the boom, "our stock price would've been down and a lot of investors were already thinking the PMI business was irrelevant."

The near-term outlook is largely glum, with more credit losses expected. Farther down the road, analysts and the industry say the mortgage insurance business could return to growth as lenders forsake piggyback loans. Until then, investors aren't likely to have much sympathy for the group. On Friday, PMI, MGIC and Radian shares closed at $5.50, $12.64 and $5.11, respectively.

"They got sucked in along with everybody else," says Mike Grasher, an analyst at Piper Jaffray. "As the ball kept rolling and gathering steam, the industry lost its leverage and underwriting discipline at the same time."