CONFORMING UP: Congressional leaders and the White House have agreed to raise loan limits on mortgages guaranteed by Fannie Mae and Freddie Mac. They have agreed to raise loan limits on mortgages insured by the Federal Housing Administration.

Housing Wire rounds up some details on their Web site.

I’m skeptical that these changes will help. My skepticism comes in three parts:

# By increasing the conforming loan limit (to up to $725,000 in high-cost areas such as California) for loans guaranteed by Fannie and Freddie, the government is allowing — no, encouraging — those companies to take greater risks at a time when the smart money is shying away from risky debt.
Nemo, a commenter on the Calculated Risk blog, put it best with this succinct tidbit: “I guess Fannie and Freddie weren’t too big to fail yet.”

Right now, the conforming limit is $417,000. In most of the country, that limit is ample to assure that mortgage money is available for lower- and moderate-income borrowers. In expensive areas in the Northeast, parts of Florida, and in much of California, it’s hard to find a habitable house for less than half a million dollars, and many homebuyers need mortgages of more than $417,000. They get jumbo mortgages.

For a long time, the typical rate on a 30-year, fixed-rate jumbo mortgage was about a quarter of a percentage point higher than that on a conforming loan. If a lender was offering conforming loans at 6.5 percent, a jumbo borrower could expect to get a loan at 6.75 percent, give or take.

But in August, there was a meltdown in the jumbo securitization market, as investors suddenly realized that they didn’t know how to assess the risks of the jumbo loans that they owned. In a matter of hours, everyone got scared of buying securities based on jumbo loans, and the market halted. Interest rates on jumbo loans skyrocketed. In this week’s Bankrate.com survey, the average rate on a conforming mortgage was 5.57 percent, and the average jumbo was 6.85 percent. In the old days, that jumbo rate would have been about a full percentage point lower.

Now political leaders are saying that Fannie and Freddie should guarantee some of those loans that private investors are afraid of. Fannie and Freddie are private corporations, but they are also government-sponsored enterprises, or GSEs, and a lot of investors believe that there’s an implicit guarantee that the federal government will bail them out.

What if you believed that the government would refund your money from an investment gone bad? Would you act less carefully? Of course you would.

In September, Fed Chairman Ben Bernanke testified before the House Financial Services Committee about mortgage lending. He said:

“Some have suggested that the GSEs could help restore functioning in the secondary markets for non-conforming mortgages (specifically jumbo mortgages, those with principal value greater than $417,000) if the conforming-loan limits were raised. However, in my view, the reason that GSE securitizations are well-accepted in the secondary market is because they come with GSE-provided guarantees of financial performance, which market participants appear to treat as backed by the full faith and credit of the U.S. government, even though this federal guarantee does not exist. Evidently, market participants believe that, in the event of the failure of a GSE, the government would have no alternative but to come to the rescue. The perception, however inaccurate, that the GSEs are fully government-backed implies that investors have few incentives in their role as counterparties or creditors to act to constrain GSE risk-taking. Raising the conforming-loan limit would expand this implied guarantee to another portion of the mortgage market, reducing market discipline further. If, despite these considerations, the Congress were inclined to move in this direction, it should assess whether such action could be taken in a way that is both explicitly temporary and able to be implemented sufficiently promptly to serve its intended purpose. Any benefits that might conceivably accrue to this action would likely be lost if implementation were significantly delayed, as private securitization activity would likely be inhibited in the interim.”

Congress didn’t totally ignore Bernanke. The politicians say that these increased loan limits are temporary, and they want to act swiftly.

Here’s the second reason that I’m skeptical that raising the loan limits will help:

# To get a conforming or FHA-insured loan, you have to document your income and assets.
Herb Greenberg, of Marketwatch, nails it here, pointing out: “Without stated income for wage earners, it’s tough to qualify for a $700,000 loan.”

Even in California.

Greenberg asserts that 70 percent of all jumbos from 2005 to 2007 were stated-income, and for good reason: Most of those borrowers lied about their incomes so they could qualify. Greenberg says 90 percent lied. In the subset of stated-income borrowers who were wage-earners and not small-business owners, he’s probably not far off.

# The third reason for my skepticism can be summed up with this quote from Greenberg: “Refis will still have trouble due to values dropping in jumbo areas by such a large amount. These are the ones that really need the help.”
Bingo.

Even if Fannie and Freddie and the FHA can guarantee or insure loans of upwards of $700,000, it won’t do you any good if you owe more than the house is worth. If you owe $600,000 on an ARM, and the house is now worth $500,000, no one is going to give you a $600,000 fixed-rate loan.

Once again, capital is getting more consideration than consumers. Banks are free to underwrite bigger mortgages, but they’re not being pressured to forgive debt that they should never have underwritten in the first place.

The fastest and cleanest way to get out of this housing and mortgage mess is to make lenders forgive debt on loans for houses that have lost a lot of value. Home prices in much of the country went unsustainably high during the bubble. Those prices need to fall in relation to incomes. Either prices will stagnate for a decade or more while median incomes rise, or prices will fall. By raising the conforming limits, Congress is encouraging prices to stagnate. That surely doesn’t do first-time homebuyers any favors. They’ll have to remain on the sidelines for a few more years. It doesn’t really help current homeowners much, either.

Mortgage Matters is a blog on housing and mortgage issues written by Senior Reporter Holden Lewis.

– Posted: Jan. 25, 2008