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Reflections On Mortgage Rescues And Remedies

The current trials and tribulations of the home mortgage market stem from a re-pricing of risk. There is no shortage of mortgage money — quite the contrary; an army of loan providers out there are desperate for customers. The problem is that some kinds of customers are no longer eligible under the new rules, and others who remain eligible must now pay a much larger premium over the best price than was the case earlier.

An industry that had become conditioned to rules that allowed most anyone to get a loan now must turn customers away. This is painful, just as denying a heroin addict the fix to which he had become accustomed is painful. But we try to be compassionate with addicts and help them make the transition to a normal life as easy as possible. Is there something that can be done to make the market’s transition less painful?

Some are proposing that the Federal Reserve step in to lower interest rates. There isn’t a lot of scope for that because mortgage rates today are only about 1 percent above their lowest point reached in mid-2003. Further, the Fed has many more things to consider in setting its policy targets than the transitional pain of the home loan market.

But even if the Fed viewed pain relief in the home loan market as a priority, lowering the general level of rates would mainly help the mortgage borrowers who don’t need help. Lowering rates will not affect the investor guidelines that have made some borrowers ineligible. Those who have become ineligible under the new rules would remain ineligible. Rates in the high-risk niches that are still being priced probably would fall a little, but nothing to match the previous price increases.

In short, there would not be a lot of benefit to set against the costs of changing Fed policy to one that is more liberal than the Fed would have selected otherwise.

I hear rumors that Fannie Mae and Freddie Mac have proposed that they be allowed to help by making loans they are not now authorized to make, specifically “jumbo” loans larger than their current limit of $417,000. The agencies would dearly love to get out from under that limit, which is going to run through 2008 and maybe even beyond if housing prices don’t recover.

But there is no shortage of money for jumbo loans, the shortage is in the higher-risk niches, some jumbo but many not. A credible offer by the agencies would be to make loans in high-risk niches that the private market has now placed out of bounds, and/or to offer better prices in high-risk niches that the agencies believe are being overpriced. In either case, the agencies should define these niches exactly as they would appear in their underwriting manuals, and provide credible evidence that the niches are closed or overpriced.

I’m not sure that, even if the agencies provided an explicit and valuable quid pro quo, the deal would be a good one. Fannie and Freddie are already far too big. If it were my call, I would freeze their loan limits forever so that their market share (and political clout) gradually declined. If the limit were raised instead, there should be an attached sunset clause that automatically terminates the authority after a specified period, such as 12 months.