Fannie Mae and Freddie Mac have built their businesses around providing housing opportunities for the common' American. But amid pressure from mounting mortgage resets, Federal Reserve Chairman Ben Bernanke has floated the idea of raising Fannie and Freddie conforming limits to include Jumbo loans up to $1 million, which some market participants feel will not garner enough support.
"What Fannie and Freddie come from, what their roots are, is promoting home ownership for regular Americans, not rich Americans," said a market participant. "I think that raising the conforming loan limit to $1 million represents bad public policy. You are devoting tax payer resources to promote housing for rich people. And you don't need to do that," he said.
While Fannie and Freddie are packaging the loans into securities, the Federal government is going to guarantee these loans. Many noted that a government bailout would be in order if a GSE ran into portfolio trouble. "I think the overwhelming majority of people in the RMBS market are against it," the market participant said. "Giving more business to Fannie and Freddie takes bread off their table." The GSEs were previously scrutinized for taking business away from many private mortgage companies that did not have any government affiliation.
To be sure, many feel that a $1 million cap would run contrary to Fannie and Freddie's mission to support middle class housing and generate a lot of opposition in the market. "What has been out there in this debate [over raising the conforming limit] is that there is a trade off between getting Fannie and Freddie to help with the liquidity in the private label mortgage market but also to focus their mission on affordable housing and supporting moderate income and middle class people trying to buy homes," said Art Frank, head of agency MBS research at Deutshe Bank.
Also fueling concern is the fact that a larger conforming limit could potentially double the GSE's portfolio. Previously the government had sought to limit Fannie and Freddie's growing monopoly on the mortgage sector.
A Jumbo Help
However, some acknowledge the need for a cap increase for GSEs, particularly in regions of the country where the median price of a home is higher. While a $417,000 limit is fine for Wichita, Kan., it is low for areas like San Francisco where the average home price is higher, Frank said. So maybe you raise it 50% for San Francisco, he added, pointing out that the house passed a bill in May 2007 that would raise the conforming limit by 50% in the highest cost areas, but the senate has yet to act on it. Others agreed, suggesting that the market could meet halfway on Bernanke's suggestion. "I think maybe they will agree on a compromise and maybe go up to $500,000 to $600,000," said a NY-based banker.
Other market players say increasing the limit is a progressive idea for the market, and would encourage financial institutions to make loans to credit worthy customers. This would do a lot for easing the psychological fear that is permeating the market right now. It doesn't mean [Fannie and Freddie] are going to buy loans up to $1 million and not buy loans under $250,000, said the banker. I think [Fannie and Freddie's] business model has to evolve over time. A business model that was relevant 20 years ago cannot be relevant forever. It has to be responsive to the change in the market place.
Indeed, it looks like the extended guidelines of $417,000 to $1 million that Bernanke proposed will probably cover 15% to 30% of a typical 2006 subprime pool, assuming average loan composition, said Quincy Tang, senior vice president at DBRS. "And that is a fairly sizable amount compared to the $450 billion to $500 billion of subprime loans that are about to reset," Tang said. "This proposal will likely cover about $100 million and up of those resets. It makes it pretty sizable in addition to the FHASecure program that is already in place. From that perspective it is definitely a constructive proposal," she said.
While there are no specific guidelines yet, Tang, amongst others, expects the GSEs to exercise prudence in selecting what they want to guarantee. "It is not going to cover as many borrowers as the industry would hope them to," she said. "[Fannie and Freddie] now do a substantial amount of due diligence (sometimes reviewing up to 50% of the mortgage loans that they buy) and they often reject a sizable portion of those loans based on their due diligence," Tang said. "Clearly these firms are going to be very cautious in what loans they want to guarantee and put into this program."
Furthermore, most of the pressure to mitigate risk will continue to fall on servicers. The FHASecure will probably cover 20% of the subprime resets and the extended guidelines for the GSEs will probably cover another 20%. The rest will fall heavily on the servicers, whether it is through potential modifications, or repayment plans or other loss-mitigation practices, Tang said.
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