Friday, January 25, 2008

We’ll See – Part Two


Yesterday’s blog discussed the tax-rebate portion of the economic stimulus package.

But there’s another part to the package – designed to boost the sinking residential-real-estate market. The Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) make markets in mortgages. Once upon a time, banks made mortgage loans and held those mortgages in their portfolios. The federal government created Fannie and Freddie to allow mortgage originators to sell their mortgages and collect a fee for their services, thereby replenishing the originators capital and allowing the originator to write more mortgages. Fannie buys and holds mortgages, using funds generated by the sale of bonds (debentures) in the capital markets. Freddie buys mortgages and then bundles them into securities that it sells to investors. (You can recognize the forebears of the collateralized debt obligations that investment bankers created to finance their mortgage purchases.)

Problem is: Fannie and Freddie currently can’t make markets in jumbo loans above $417,000. Consequently interest rates are higher on jumbo loans, and these loans have recently become more difficult to obtain. The stimulus package would change that.

Here’s an excerpt from today’s San Francisco Chronicle ( that presents an excellent summary of the proposed changes together with a relevant example.

How stimulus package will work

“What: The tentative economic stimulus package would raise the limits on mortgage loans Fannie Mae and Freddie Mac can acquire. For one year, the limit would be 125 percent of an area's median cost, up to $729,750, a big jump from the current $417,000.* Likewise, the package would raise the limits for Federal Housing Administration loans up to $729,750 in high-cost areas, up from the current $362,000.

“Why it matters: Mortgages backed by Fannie and Freddie carry an interest rate a full percentage point or more lower than "jumbo" loans.

“Local impact: The Bay Area median home price stood at $620,000 in December. If the loan cap is raised, many more homeowners and home purchasers here would qualify for "conforming" loans at lower interest rates.

“Examples: For a 30-year fixed mortgage of $550,000, the monthly savings would be $353, Sen. Barbara Boxer's office said. For a 30-year fixed mortgage of $650,000, the savings would be $417 a month.

“What's next: The package has to pass the House, which seems likely, and then go to the Senate. Congress aims to get a bill to President Bush by mid-February. Experts said if the loan cap is raised, the new limit would be reflected in mortgage offerings almost immediately.

“More information:;;

“*The limit is now $625,500 in Hawaii, Alaska and Guam, which were once viewed as the nation's highest-cost areas.”

This plan would reduce the interest cost on jumbo loans and thereby improve the market for homes in areas were real-estate values are high. The big question, of course, is, “Will it work?”

It will be of some help, but can’t – by itself – correct the fundamental problem. We are in the midst of an asset deflation that some observers believe will become more severe as the year unfolds. As home prices fall, some owners will dump homes in the hope of getting a better price than they might receive a year from now. Potential buyers will hold back, waiting for prices the fall further. Supply is stimulated and demand restrained. Market forces behave perversely during the downdraft until a bottom is finally reached.

The proposed relief will help, but probably not reverse the fundamental – and destructive – forces at work.

© 2008 Michael B. Lehmann

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