Dear John

What's the intro for a long-dead soap opera, supposedly set in Santa Barbara but actually filmed in Burbank, doing on the Inman Blog? You'll have to click on "continue reading" to hear about the real-life Valentine's Day drama unfolding in Santa Barbara County, which involves Fannie, Freddie and a "Dear John" letter.

The Santa Barbara Association of Realtors wants the Department of Housing and Urban Development to split the county in two in order to calculate the new temporary increase in the conforming loan limit. Otherwise, housing prices in poorer part of the county will keep the region SBAR represents from reaching the maximum $729,750 cap.

The stimulus bill signed into law by President Bush last week will raise the conforming loan limit for mortgages eligible for purchase by Fannie Mae and Freddie Mac in high cost areas to 125 percent of the median home price for a county or metropolitan statistical area (see previous post)

According to the California Association of Realtors, the median price for a single-family detached home in wealthy southern Santa Barbara County was $925,000 in December -- down 26 percent from $1.25 million a year ago.

Residents of the city of Santa Barbara and neighboring Montecito, Goleta and Carpinteria would see the conforming loan limit for their area go up to the maximum, temporary cap of $729,500 allowed under the formula in the stimulus bill. That is, if it weren't for their poorer relations to the north, in Lompoc, Santa Maria and Santa Ynez, where the median home price in December was just $323,810, after an equally abrupt 25 percent annual decline from $431,710.

If HUD looks at the county as a whole, the conforming loan limit will only go up to $587,500, the Santa Barbara Association of Realtors complains. (If you look at the latest numbers from DataQuick, which includes condos, the median home price in Santa Barbara County as of December was $392,500, and so the adjusted conforming limit would be even lower -- $490,625).

The association is asking members to download a form letter addressed to HUD Secretary Alphonso Jackson and a certain "John Lockhart," who is identified as the director of the Office of Federal Housing Enterprise Oversight, the regulator of Fannie and Freddie.

"This increase is not nearly enough given the fact that the median sales price for a home in 2007 in South County (Goleta, Santa Barbara, Montecito, and Carpinteria) was $1,231,000 and the median sales price for a condo was $629,000," the Dear John letter says. "I ask for your immediate assistance in splitting North and South Santa Barbara County for the new and future conforming loan limits. The current new estimated amount of $587,500 will have little or no impact on improving the market here in Southern Santa Barbara County. We need your help with the conforming loan limits so it can actually help the people who need it."

Let's forget, for a moment, that the director of OFHEO is James Lockhart, not John Lockhart. And let's also not dwell on the fact that if HUD did decide to divide Santa Barbara County in two for the purpose of calculating the conforming loan limit, that the limit would not go up at all in the poorer, northern half of the county.

There's a larger debate to have, which is whether Congress has done a good job of ensuring that the benefits of Fannie and Freddie's mortgage purchase and guarantee programs benefit people of low and moderate incomes -- and whether it should even try.

If setting the conforming loan limit at $417,000 everywhere in the country (except Alaska and Hawaii) seems -- like those proposals for a federal flat tax -- overly simplistic, the can of worms Congress has opened up by tying the conforming loan limit in high cost areas to regional home prices (at least for a few months) doesn't seem like a great solution, either.

For one thing, since the conforming loan limit in "normal" markets is still tied to national median home price (sort of*) it will remain $417,000 in most parts of the country. So you've got the same problem you had before: In a market like Akron, Ohio, where the fourth quarter median home price was $109,100, you've got Fannie and Freddie helping finance what are, for those areas, mansions for the wealthy priced at up to $521,250 (with a 20 percent down payment of $104,250).

And while it's true that even modest homes in thriving metropolitan areas like New York City and San Francisco may now require jumbo loans, it's hard to believe many low- or moderate- income families are buying them.

Now, because investors who buy mortgages in the secondary market have pretty much stopped buying loans that don't have backing from Fannie, Freddie or FHA, Congress wants to let them each venture into "jumbo light" territory, and help people buy $912,187 homes (with a 20 percent down payment of $182,437 and a $729,750 mortgage).   

The primary mission of Fannie and Freddie has always been to provide liquidity to the mortgage markets when credit is tight. And the consensus right now seems to be they've done a great job doing that during the credit crunch -- and that things would be a whole lot worse without them.

But some have also complained that the government-chartered mortgage financiers of adding fuel to the fire by buying up subprime loans packaged into mortgage-backed securities MBS.

According to analysts at Credit Suisse, Fannie and Freddie hold about $230 billion in MBS backed by subprime or alt-A mortgages, and they may be about to write down the value of those securities by $16 billion. On the day Congress approved the stimulus package and raised conforming loan limits in high cost areas, OFHEO director Lockhart told Senate lawmakers he thinks that loss estimate is too high. But he also said one reason Fannie and Freddie have been buying subprime and alt-A MBS is to meet affordable housing goals set by Congress.

Now, as Fannie and Freddie's mounting losses force them to scrape up more capital -- just like the Wall Street investment banks that securitized most subprime loans -- executives at those companies have found themselves unable to take advantage of the additional leeway they have been given by OFHEO to grow their investment portfolios. While they have more capacity to guarantee loans that are securitized and sold to investors, that's a slower process, and it remains to be seen what kind of appetite investors will have for "jumbo light" loans backed by Fannie and Freddie.

If the quickest way for Fannie and Freddie to provide relief for the jumbo loan market is to buy jumbo light and hold them in their investment portfolios, that will reduce the number of smaller loans they can buy. As Lockhart noted in his testimony, one $600,000 loan requires as much capital as three $200,000 loans.

So asking Fannie and Freddie to provide relief to jumbo loan markets at a time when the GSEs are bumping up against their capital requirements seems like asking them to prop up prices in affluent markets at the expense of poor and moderate income families. It's hard to argue that's not going to be the case if HUD decides to split Santa Barbara County in two for the purposes of calculating the new limit.

*It seems like an eternity ago now, but in November OFHEO was proposing LOWERING the conforming loan limit next year, in concert with the decline in national home prices. As far as I know the proposal still stands, but Congress may implement a permanent increase in the conforming loan limit as of pending legislation that would strengthen oversight of Fannie and Freddie.

While such a move seems unlikely in the current political climate, you have to ask yourself -- why not? If home prices are falling, and you believe Fannie and Freddie should help low- and moderate-income families first, why not lower the limit to reflect falling home prices?

Or, to take an even more radical view, why not just do away with the conforming loan limit altogether, and let the GSEs decide themselves what size loans they will back in each market? If a one-size fits all approach (one uniform limit for the entire country) doesn't work, maybe the situation in Santa Barbara County demonstrates that a county or MSA approach isn't granular enough, either.

Congress could still mandate that Fannie and Freddie meet affordable housing goals, without forcing the federal government to micromanage by setting limits in every housing market in the land. Or forget about the affordable housing goals -- after all, isn't that how Fannie and Freddie ended up with all that subprime and alt-A MBS exposure?

Still another approach -- one taken by House Democrats in the GSE reform bill they sent to the Senate last year -- would be to take a portion of Fannie and Freddie's profits and put them into an affordable housing fund.

The problem with making changes on the fly, the way Congress has done with the stimulus bill, is you have to deal with the law of unintended consequences -- like Santa Barbara.

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