In search of a fix for jumbo loans

The new jumbo loans that were supposed to get the real estate market moving haven't done the trick. A congressional hearing on Thursday examines why.

By Les Christie, CNNMoney.com staff writer
Last Updated: May 23, 2008: 3:09 PM EDT

NEW YORK (CNNMoney.com) -- When the housing crisis hit last summer, it became very hard for borrowers to land the jumbo loans they needed to buy homes in high-priced areas, like California and New York.

So as part of the Economic Stimulus Act, Congress tried to get funds for jumbo loans flowing again by temporarily raising the dollar limits for mortgages that Fannie Mae (FNM, Fortune 500) and Freddie Mac (FRE, Fortune 500) can buy. The two government-sponsored entities (GSE) had previously only been permitted to buy so-called conforming loans of up to $417,000 and then resell them on the secondary market.

The new limits raised that conforming loan cap to as much as $729,750 in some high-priced metro areas through Dec. 31, in order to make home loans more readily available to help stabilize falling markets.

But the move hasn't juiced the market, and so the House Financial Services Committee is holding a hearing Thursday to examine why.

"The liquidity crisis in mortgages has given added impetus to expanding the conforming loan limit in high-cost areas. As the correction took hold last fall and winter, jumbo and other non-conforming lending all but ground to a halt in many markets," said Thomas Lund, executive vice president for Fannie Mae in his testimony.

Higher prices persist
Despite the increased caps, these new "conforming jumbo" loans - between $417,000 and $729,750 - are still more expensive than the conforming loans below $417,000.

For months after the conforming jumbos were introduced, interest rates for them ranged between a point and a point and a half higher than on regular conforming loans. That made jumbo loans much more expensive; for a $600,000 mortgage, a borrower paid an extra $400 to $600 a month.

In the past, the spread between jumbo and conforming loans was much smaller, a quarter point or so.

"[The raised caps] produced less activity than I thought they would," said Rep. Barney Frank, D-Mass., in opening remarks at the hearing.

"Beneficial effects have be slow to materialize," added Spencer Bachus, R-Ala., ranking member on the committee.

The problem: The investors who buy mortgages on the secondary market still consider these new conforming jumbo loans riskier than the original conforming loans, and put a higher risk premium on them.

"The ultimate investor was not comfortable with the prices of the new jumbos," said Rob McDonald, director with the global business advisory firm FTI Consulting. "The secondary market participants needed to accept the prices Fannie and Freddie were offering."

That reluctance comes despite the fact that buyers who use jumbo mortgages tend to be better credit risks and often put more money down, McDonald said.

Part of the problem is simply that fear is contagious.

"If there's a credit squeeze, despite the higher credit profiles of jumbo loans, there's hesitancy on the part of mortgage backed securities buyers," he said. "This gets to the correlation between subprime secondary mortgage markets and conforming secondary markets."

A different kind of security
Indeed, Fannie and Freddie don't actually package conforming jumbos for sale to investors in the same way they treat sub-$417,000 conforming loans. They are not what's called "TBA-eligible." These are "to-be-announced" transactions where the purchase price is settled at some future date.

The Securities Industry and Financial Markets Association decided in February to exclude jumbo conforming loans from TBA-eligible pools. But the TBA market is well established and understood by investors, according to Jay Brinkman, an economist with the Mortgage Bankers Association.

"Buyers of securities feel very secure about this market," he said. "They're accustomed to the pricing and they know how the securities perform."

The exclusion of conforming jumbos from that market makes them a somewhat unknown security. "No one is sure what their performance will be, so no one is sure how to price them," said Keith Gumbinger of HSH Associates, a publisher of mortgage market information.

The Mortgage Bankers Association argued that the new conforming jumbos should be issued as TBA products, but there was resistance to this. Others were hesitant to introduce any new element that might harm the conforming loan market.

"They said, 'The conforming market is the only one really functioning. Don't mess it up by adding jumbos to it,'" said Brinkman. Indeed, jumbos perform differently for investors than conforming loans.

Jumbo borrowers are more likely to pay off their loans early, which cuts off the revenue stream of their interest payments for investors, while those with $100,000 mortgages tend to keep making the same monthly payment year after year.

If jumbos were packaged with these in the same mortgage-backed securities, investors would require higher interest rates to purchase them. Borrowers of conforming loans would have to pony up the increased interest, in effect subsidizing more affluent, jumbo loan borrowers.

There are other risk factors that makes investors wary. Jumbos are, by definition, less diverse geographically; they're only available in about 70 metro areas - many of the most challenging markets in the nation.

"Look at the markets where these are offered," said Gumbinger. "It's where home prices are falling. An investor will say, 'I'll buy them but I have to get more yield out of them.'"

In early May, Fannie changed in the way these loans are handled; instead of packaging them for sale on the open market, they are keeping them in their portfolios. Fannie can set the price itself and is doing so as if the loans were TBA-eligible.

And weekly mortgage application statistics show that the pipeline for the loans has opened up during the last couple of weeks.

In March 2007, 12.1% of all mortgage loans requests were for jumbos. A year later, only 4.4% were. During the past couple of weeks, jumbos have accounted for 5.8% of all applications.

According to Freddie Mac Vice President Patricia Cook, interest rates for conforming jumbos are now a full point below regular jumbos and only two-tenths of a percentage point higher than conforming loans.

Gumbinger confirms that spreads between conforming and jumbo conforming have narrowed down to below half a point, good news for home buyers in high-priced areas.

Meanwhile, however, interest rates for non-conforming jumbo loans have not improved much, according to Gene Choi, president of Commodore Mortgage Group. "In that market, the pricing is still much higher," he said.

"In January, I had a guy buying a $1.4 million home in New Jersey whose loan was going to be in the upper sevens, 7.875% or so," said Choi. "He was very surprised."