The subprime mortgage meltdown has had a much deeper impact on the jumbo loan market than many thought it would, leaving analysts to wonder what the best solution is for galvanizing the slumping sector. While many economists believe help will come from the Federal Reserve, some lawmakers want Fannie Mae's and Freddie Mac's loan restrictions loosened to aid the jumbo market.
Most economists foresee the Fed making a one-quarter percentage point drop to the 5.25% federal-funds rate when it meets on Sept. 18, which would be its first cut in four years. But at least one market observer does not think this will go far enough to bolster the depressed market.
"The Fed must act very aggressive at this point," he said. When asked what his reaction would be if a 25 basis point cut is approved in two weeks, he said, "OK, what else have you got?" He added that the Fed should drop the interest rate by 50 basis points. "I can't imagine anything lower having any real effect," he said.
The jumbo loan market is especially important in high-priced metropolitan cities on the East and West Coasts. The market observer, who is based in California, noted that the median home price in the state is $585,000, which means very few transactions are made without a nonconforming loan. With California's home inventory rising and its home prices softening, the continuing credit crunch could prove detrimental to its economy. Asked whether the state could be pushed into a recession, the observer said, "It's entirely possible."
The mortgage rates for a 30-year prime jumbo loan was 7.21% the week of Aug. 27, according to research firm Friedman Billings Ramsey & Co. This was unchanged from the previous week but down from 7.28% for the week of Aug. 16. More significant has been the decline in yield, said Michael Youngblood, an analyst at FBR Investment Management, a subsidiary of FBR Capital Markets.
The spread between a prime loan and a Freddie Mac 30-year fixed-rate loan was 77 basis points the week of Aug. 27, an increase of 10 basis points from two weeks before and the highest it has been since April 11, 1986.
"The spread is at its historical wide," Youngblood said. "We've rolled back a generation of mortgage finance in three weeks. This is huge."
FBR had forecast a default increase this year to 51 basis points from 38 basis points, which is a modest increase, Youngblood said. This makes the historically wide spread all the more disturbing. "It is wildly out of proportion to the credit risk of the sector," he said. "The actions of the Federal Reserve and other central banks have clearly not penetrated the mortgage markets."
Youngblood is joining the growing chorus of analysts who want to see the federal-funds rate cut on Sept. 18. Federal Reserve Chairman Ben Bernanke and the Fed's decision to pump $38 billion of liquidity into the banking system on Aug. 10 has clearly made a difference, he said, but it has not gone far enough. The infusion resulted in a rebound in the broad equity index, for instance, but the housing market has not benefited much.
"The liquidity that is being lavishly hoisted upon the banking system has not restored equilibrium to the commercial paper markets or to the non-agency markets," he said.
Art Frank, director and head of MBS research for Deutsche Bank Securities, is predicting the federal-funds rate will be lowered by 25 basis points at the next two meetings of the Federal Reserve, moves that he supports. "It helped the mortgage bailout in 98," he said, adding that the liquidity situation nine years ago was even worse than it is today. While Frank said he expected the subprime credit crisis to have some impact on the jumbo loan market, he added, "I was a little shocked to the degree at which it has seeped over."
Fannie Mae has asked for a 10% raise on its portfolio caps - it can purchase single-family loans up to $417,000 in the continental United States - but the federal government is not yet willing to go that far. The changes would require the action of Congress, and Rep. Barney Frank (D-Mass.) has been vocal in his support to increase the caps.
Opinions on how much this will help the jumbo market, however, have been mixed. Both President Bush and the Office of Federal Housing Oversight, which oversees Fannie Mae and Freddie Mac, have opposed the move thus far.
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