Regulator opposes stimulus plan's mortgage fix

Government agency takes stand against letting Freddie Mac and Fannie Mae buy higher-cost loans.

NEW YORK (CNNMoney.com) -- A government agency with regulatory power over Freddie Mac and Fannie Mae opposes lifting the loan caps for the two agencies, part of the economic stimulus package announced Thursday.

The stimulus package includes a proposal that temporarily raises loan limits for the government sponsored enterprises (GSEs), Fannie Mae and Freddie Mac. That could kick start sluggish residential real estate markets in high cost areas that have suffered through the liquidity squeeze that started last summer.

The director of the Office of Federal Housing Enterprise Oversight (OFHEO), James Lockhart, came out in opposition to the measure, releasing a statement on Thursday saying, "We are very disappointed in the proposal to increase the conforming loan limit as we believe it is a mistake to do so in the absence of comprehensive GSE regulatory reform."

The agency is likely concerned that if Fannie and Freddie take on even more debt, their financial health of could be imperiled.

"No one should be shocked by OFHEO's opposition," said Jaret Seiberg, an analyst at the policy research firm Stanford Group. "Director Lockhart has been extremely consistent in his demand that any change in conforming-loan limits be paired with legislation creating a stronger regulator."

According to Seiberg, Lockhart believes OFHEO lacks sufficient power to police the two GSEs. He believes that Lockhart wants to see many of the provisions included in the GSE reform bill, which would give OFHEO more authority over the GSEs, enabling it to establish stricter standards for lending and capital management. The bill has been languishing in Congress for about a year.

On Friday, Senator Chris Dodd, D-Conn., who chairs the Senate Banking Committee, pledged a renewed effort to get that bill through the Senate. That should be easier now that he's off the presidential campaign trail. One industry insider, speaking on background, said that when Dodd was running for president, nothing moved out of committee

The GSEs were created to ensure liquidity in mortgage markets. Lifting the caps on the size of mortgages that the GSEs purchase in secondary markets would advance that mission, and enable more buyers to procure financing.

But, increasing the dollar value of loans the GSEs are permitted to buy -- possibly to as much as $729,000 in some high cost areas, up from a maximum of $417,000 -- also increases the risk the agencies take on.

Many of these new, larger loans would be issued in expensive California markets where home prices have been in free fall. Plunging home values add to default rates by robbing home owners of equity they can tap when they hit a rough patch.

If a substantial proportion of the new, high-value loans default, the GSEs could take huge hits, on top of already substantial losses over the past few years.

That's where OFHEO's opposition stems from; it's main goal in advocating GSE reform, according to a speech Lockhart made this past December, is to promote safety and soundness in the enterprises.

Already, the GSEs have shown themselves to be vulnerable. Just six weeks ago, Freddie CEO Richard Syron forecast losses of at least $5.5 billion over the next couple of years from bad loans -- but they have already amassed huge obligations.

According to OFHEO, Fannie and Freddie together have debt of more than $1.5 trillion, and have guaranteed mortgage backed securities of more than $3.3 trillion, a total debt of nearly $4.9 trillion.

And this debt isn't backed by a lot of cash. Both Fannie and Freddie have minimum capital requirements of just 3.25 percent of assets - considerably lower than the 4 percent required for private lenders - making the agencies, at least potentially, very vulnerable.

"OFHEO," said Mark Zandi, chief economist for Moody's Economy.com, "wants to make sure the GSEs are following sound procedures and have sufficient capital."

And, according to Zandi, OFHEO's position has long been backed by the administration - until recently. But the mortgage meltdown, the stock market slump, job weakness and a looming recession, have overrun that position. Easier mortgage financing became part of the stimulus package; at least for now.

"What's particularly interesting," said Seiberg, "is that the word is that we could have opposition from Senate Republicans to including the GSE provisions in the stimulus package."

According to him, a spokesman for Senator Richard Shelby (Ala.) has already come out against it, as has Senator Mel Martinez (Fla.).

"There's a lot of clear momentum to get the package done," said Seiberg, "but it's not a slam dunk getting the GSE provisions included."