The government takeover of mortgage financiers Fannie Mae and Freddie Mac could mean lower interest rates for many borrowers but is unlikely to solve one of the biggest problems of the credit crunch: the shrinking number of people who can get a loan in the first place.
Fannie and Freddie will be permitted to expand their direct investments in mortgage-backed securities from $1.5 trillion to $1.7 trillion over the next year. With the government standing behind their debts, investors are also expected to be more willing to buy mortgage-backed securities guaranteed by Fannie and Freddie.
That could push the rate for a 30-year fixed-rate conforming mortgage down from 6.35 percent last week to "well below" 6 percent, according to Mark Zandi, chief economist at Moody’s Economy.com.
Rates are already coming down to around 6 percent today, but it will take 30 to 45 days to get a sense of how the takeover will ultimately affect rates, said John Courson, chief operating officer of the Mortgage Bankers Association.
Today’s lower rates "could be a one-day reaction," Courson warned. But the Treasury’s actions have "put a safety net under (secondary markets where mortgages are sold) that restores investor confidence … that should be a driver that leads to lower rates."
In a commentary for Moody’s Economy.com’s Dismal Scientist newsletter, Zandi said lower interest rates won’t stop further house-price declines, but "raises the odds" that those declines will not exceed 5 percent to 10 percent of current levels.
Columbia Business School real estate professor Chris Mayer has estimated that higher borrowing costs — as reflected by the unusually wide spread between mortgage rates and Treasurys — has increased the cost of owning a home by 10 percent to 20 percent (see story).
With the government’s explicit backing of Fannie and Freddie’s debt, Zandi and others think the spread will return to levels more in line with historic norms.
"The immediate impact, already in evidence today, is clearly that the spreads between U.S. Treasurys and Fannie and Freddie securities have gotten a lot narrower," said Robert Satnick, chairman of the California Mortgage Bankers Association. "A tremendous amount of uncertainty has been taken out of the conforming mortgage market."
Dan Green, a loan officer for Chicago-based Mobium Mortgage Group Inc., sees mortgage rates improving in the short term, which will make homes more affordable by lowering borrowers’ monthly payments. But Green, the author of The Mortgage Reports blog, sees a recovery in housing markets tied less to mortgage rates than to the availability of credit.
Until would-be home buyers and homeowners who have been "frozen out of the mortgage market in the last 12 months" have access to money, "a recovery won’t be as quick as it should be," Green said.
While Congress has raised the conforming loan limit — the ceiling for mortgages eligible for purchase or guarantee by Fannie and Freddie — many borrowers in high-cost markets remain in "jumbo loan" territory.
Congress and the Bush administration have been allowing Fannie and Freddie to purchase and guarantee mortgages of up to $729,750 in high-cost markets until the end of the year. But the cap will be lowered to $625,550 on Jan. 1, and in markets where home prices didn’t head into the stratosphere the old $417,000 conforming loan limit has remained in place.
So far, Fannie and Freddie haven’t done much with the authority they were granted to purchase and guarantee mortgages above the old conforming loan limit. But with an infusion of capital from the Treasury, "they will have the financial muscle to do what Congress originally intended," Zandi said.
Because Fannie and Freddie aren’t allowed to turn jumbo loans into guaranteed securities that are purchased by investors, those loans are costlier and harder to obtain. That’s an especially acute problem in high-cost markets like California, where many homes are priced well above the conforming loan limit.
Satnick said it’s too early to judge the impact of the takeover on the "nonconforming" (jumbo) loan market, but he doesn’t expect the spread between the rates for conforming and jumbo loans to grow any wider. That means that if rates on conforming loans do come down, jumbo rates should follow suit.
Courson also expects jumbo and conforming rates to move in sync, although the margin between conforming and jumbo loans won’t necessarily narrow, he said.
Those seeking a loan that falls within Fannie and Freddie’s limits must still cope with higher fees and tightened underwriting standards instituted during the downturn. Many borrowers are being told to bring larger down payments to the table, if they can get a loan at all. Fannie and Freddie have eliminated zero-down loans, and many private mortgage insurers are requiring minimum down payments of 5 percent in declining markets.
Green said many of the changes Fannie Mae instituted in its latest version of its automated underwriting system, Desktop Underwriter 7.0, are more subtle and have not been widely publicized, but have a real impact on housing markets. When purchasing investment properties, for example, borrowers can’t use rental income from the property to qualify unless their loan-to-value (LTV) ratio is 70 percent or less.
"If you are getting $2,500 a month in rent, and making a 20 percent down payment, to Fannie and Freddie that $2,500 doesn’t exist," Green said. "When you get into the deep, dark changes in the guidelines, it goes beyond (loan-to-value ratio), but to a desire of having a risk-free loan."
In announcing a $2.3 billion quarterly loss last month, Fannie Mae officials said the changes they’ve made to Desktop Underwriter helped reduce by 80 percent purchases and guarantees of the kind of mortgages that accounted for most of their losses. Fannie Mae said it would stop buying Alt-A mortgages — riskier loans often made with little or no documentation — altogether by the end of the year.
While critics have derided Alt-A mortgages as "liar loans," they can be the only option for some buyers, including investors and the self-employed. Alt-A loans aren’t inherently bad, but did perform poorly when other risks were "layered" on top of them, Courson said.
"It’s the risk layering — high LTV, no income verification, no FICO — that’s where those loans get into trouble," Courson said. Although the MBA does not advocate a return to "some of the ill-conceived credit practices" that helped produce the current crisis, it would encourage the government, in its role as conservator of Fannie and Freddie, to reconsider some of the recent guideline changes.
One reason Fannie and Freddie instituted new fees and tightened guidelines was the need to generate revenue and raise capital, Courson said. With the government preparing to provide $100 billion each in backing for Fannie and Freddie, that’s a less immediate concern.
"I think there were some loans they made a decision not to make that may well become available" again, Courson said.
The government takeover is viewed as a short-term solution — the Treasury Department’s authority to backstop Fannie and Freddie expires at the end of next year. It will be up to the next administration to determine whether the government will step in and take over the role Fannie and Freddie played in the mortgage markets, or perhaps spin them off as private companies once they return to health.
Courson said the crisis presents an opportunity to take a step back and look not only at how Fannie and Freddie might be fixed, but at the secondary mortgage market as a whole. One question to consider, he said, is whether the Federal Home Loan Banks could be allowed to purchase and securitize loans made or purchased by their member banks.
"This is an opportunity to take a blank sheet of paper, and ask what is the best structure, without limiting ourselves to what we’ve got," Courson said.
In announcing the takeover Sunday, Treasury Secretary Henry Paulson said there is an inherent conflict in the way Fannie and Freddie are structured — as private companies that aim not only to generate profits for shareholders but fulfill a public mission as defined by Congress.
The problem with that dual mission, critics of Fannie and Freddie have said, is that shareholders reap the benefits when times are good, and taxpayers foot the bill if things go wrong.
"There is a consensus today that these enterprises pose a systemic risk and they cannot continue in their current form," Paulson said. "Government support needs to be either explicit or non-existent, and structured to resolve the conflict between public and private purposes."
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