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Congress OKs Stimulus Bill, Loan Limit Increase

February 8, 2008

By Matt Carter
Inman News

Bush administration officials renewed their calls for Congress to pass legislation tightening oversight of Fannie Mae and Freddie Mac Thursday, as Congress signed off on a plan to allow the companies to guarantee or purchase loans that exceed the $417,000 loan limit.

Senate Democrats on Thursday abandoned an attempt at a broad expansion of a $150 billion economic stimulus bill backed by the Bush administration and approved by the House last month.

In an 81-16 vote, the Senate sent a slightly modified version of the bill back to the House, which promptly voted 380-34 to put the bill on the president's desk.

The White House issued a statement saying President Bush could support the Senate's more limited amendments, which expand the pool of those eligible for tax rebate checks to include $300 payments to Social Security recipients and disabled veterans.

Bush said the bill "would quickly put money into the hands of the American people and provide our economy the boost it needs" and that he will sign it into law.

The economic stimulus package includes a provision that will temporarily raise the conforming loan limit to allow Fannie and Freddie to purchase or guarantee many jumbo mortgages originated between July 1, 2007, and Dec. 31, 2008.

The increase, to as much as $729,750 in high-cost areas, will also apply to Federal Housing Administration loan guarantee programs. Because the increase will be capped at 125 percent of the median home price for an area, the conforming loan limit will remain at $417,000 in markets where the median home price is $333,600 or less.

Although the increase will expire at the end of the year, industry groups like the National Association of Realtors have urged Congress to mandate a permanent increase in the conforming loan limit in passing legislation to increase oversight of Fannie and Freddie.

Permanent changes to FHA loan limits are being addressed in bills that would also lower minimum down-payment requirements and expand the pool of eligible borrowers by using risk-based pricing. Both the House and Senate have passed FHA modernization bills, but differences between them are being ironed out (see Inman News story).

Buying or guaranteeing jumbo loans will present new risks for Fannie Mae and Freddie Mac, and increase their exposure in risky real estate markets such as California, the federal official responsible for overseeing their safety and soundness told Senate lawmakers Thursday.

James Lockhart, director of the Office of Federal Housing Enterprise Oversight, said underwriting the larger loans will require new models and systems, which could take months to put in place. As Fannie and Freddie get set to venture into what is now jumbo loan territory, Congress must act quickly to ensure they don't put themselves -- and the entire financial system -- in jeopardy, Lockhart said.

Constraints placed on Fannie Mae and Freddie Mac in the wake of the management and accounting scandals that shook both companies in 2003 and 2004 helped limit their losses during the housing downturn, Lockhart said.

But as Fannie and Freddie put those scandals behind them and prepare to start purchasing and guaranteeing loans that had previously been off limits, Congress must pass legislation creating a strong, independent regulator to oversee their safety and soundness, he said.

Since August, when investors who financed mortgage lenders during the housing boom stopped buying most mortgage-backed securities not guaranteed by Fannie and Freddie, the companies have played a crucial role in providing liquidity, stability and affordability to the mortgage markets, Lockhart said.

He said the government-sponsored entities, or GSEs -- Fannie Mae, Freddie Mac and the 12 Federal Home Loan Banks -- are now financing or guaranteeing up to 90 percent of mortgage originations.

"The GSEs have become the dominant funding mechanism for the entire mortgage system in these troubling times," Lockhart said in testimony before the Senate Banking Committee. In doing so, "they have been reducing risks in the market, but concentrating mortgage risks on themselves."

Fannie and Freddie reported combined losses of $3.5 billion during the third quarter, and both companies are expected to post annual losses for the year -- the first annual loss in Freddie Mac's history, and the first in 22 years for Fannie Mae.

The losses stem mostly from write-downs of investments, rather than borrowers defaulting on loans Fannie and Freddie have purchased or guaranteed. Fannie and Freddie hold about $230 billion in mortgage-backed securities (MBS) that carry AAA investment-grade ratings but are backed by subprime or alt-A mortgages, analysts at Credit Suisse estimate. Credit Suisse analysts project the companies could be forced to recognize $16 billion in fourth-quarter write-downs in the value of those securities.

The potential write-downs identified by Credit Suisse are greatest at Freddie Mac -- between $8 billion and $11 billion -- which reports fourth-quarter results Feb. 28. Fannie Mae faces an estimated $2.5 billion to $5 billion in MBS write-downs, according to Credit Suisse.

Lockhart told Senate lawmakers he thinks Credit Suisse's projections are too high, but said allowing Fannie and Freddie to expand their loan purchase and guarantee activities "would be imprudent unless (regulators have) significantly more powers and more flexibility to use those powers."

Thursday's hearing was held before the Senate signed off on the economic stimulus package that includes the temporary increase to the conforming loan limit.

The White House had opposed increasing the conforming loan limit unless Congress passed legislation tightening oversight of Fannie Mae and Freddie Mac. But Treasury Secretary Henry Paulson last month agreed to a temporary increase in the limit as part of the economic stimulus bill approved by the House. Paulson said he did so because Democratic leaders, including Senate Banking Committee Chairman Chris Dodd, promised to take prompt action on so-called GSE reform legislation.

Although the House has passed bills that would strengthen oversight of Fannie and Freddie -- most recently last May -- disagreements over limits on the GSEs loan portfolios and minimum capital requirements have been obstacles to Senate passage.

Thursday's hearing was held as Dodd and Sen. Richard Shelby, R-Ala., draft their own version of a GSE reform bill. Dodd promised prompt action on the issue, saying he and Shelby have proven capable of working together to draw up legislation in the past.

Fannie and Freddie are currently regulated by OFHEO, while the Federal Home Loan Banks are regulated by the Federal Housing Finance Board. The GSE reform bill passed by the House last year, HR 1427, would abolish OFHEO and FHFB and create a single, independent regulator to oversee the GSEs. The new regulator, the Federal Housing Finance Agency (FHFA), would be granted powers similar to those of bank regulators.

Assistant Treasury Secretary David Nason told members of the Senate Banking Committee that the new regulatory agency should have the power to place the companies into receivership if they become insolvent.

Treasury officials have waned that the perception that the government will bail Fannie and Freddie out if they run into financial trouble causes investors to underestimate the risk of lending money to Fannie and Freddie or investing in securities they guarantee.

"Providing the new regulatory agency the ability to complete an orderly wind down of a troubled regulated entity also encourages greater market discipline by clarifying that investors may suffer losses," Nason said.

Nason and Lockhart said FHFA should have more flexibility in setting minimum and risk-based capital requirements. By statute, Fannie and Freddie are required to maintain capital equal to 2.5 percent of assets, and Congress also created a rigid stress test for determining risk-based capital requirements.

Lockhart said OFHEO needs more flexibility to regulate minimum capital, and that the current stress test for risk-based capital requirement "is just not working, as it has yet to capture the risks we are currently observing."

Lockhart said the losses Fannie and Freddie are reporting now would have been greater if not for consent agreements the GSEs entered into, after accounting and management scandals forced both companies to fire top managers and restate several years of earnings.

The agreements restricted growth in the GSEs' loan portfolios, and boosted capital requirements by 30 percent, to 3.25 percent of assets.

"In retrospect, those agreements ... especially, the growth restrictions and the capital requirements, were extremely important in reducing the credit losses at Fannie Mae and Freddie Mac and preventing major disruptions of the conforming loan market system," Lockhart said.

Fannie and Freddie have made "major progress" toward instituting the management and accounting changes called for in the agreements, Lockhart said, and in September OFHEO eased restrictions on the GSEs' loan portfolios to allow 2 percent annual growth.

The portfolio restrictions will be lifted altogether when Fannie and Freddie return to regular financial reporting, which Fannie will do by the end of the month, Chief Executive Officer Daniel Mudd testified.

Lockhart said Fannie and Freddie have not yet utilized the additional capacity, and could grow their combined portfolios by $100 billion in the next sixth months, to $1.5 trillion, without bumping up against the new limits.

Higher capital requirements instituted in the wake of the scandals have also restricted Fannie and Freddie's growth, requiring them to raise nearly $14 billion during the fourth quarter by selling preferred stock and cutting dividends to shareholders.

The move to boost capital requirements by 30 percent, which was instituted four years ago, "was the right thing to do at the time," Freddie Mac Chief Executive Officer Richard Syron said in his written testimony to the committee.

But requiring the GSEs to maintain "the same leverage ratio as banks" would require Fannie and Freddie to institute "enormous price increases" and threaten their ability to provide liquidity to mortgage markets, Syron said. The new regulator should only be given the power to increase minimum capital standards temporarily, Fannie and Freddie executives said.

Lockhart insisted that the existing 2.5 percent capital requirement -- and the temporary increase imposed in the aftermath of the accounting and management scandals -- are low compared to other financial institutions.

Syron said Freddie Mac executives are also "very concerned" about the prospect of Congress imposing more stringent affordable-housing goals, saying "a disproportionate share" of credit losses come from loans that qualify for affordable-housing goals.

When asked by Sen. Shelby why Fannie and Freddie had purchased so many non-agency mortgage-backed securities as investments, Lockhart said those investments helped the GSEs meet affordable-housing goals set by the Department of Housing and Urban Development (HUD).

Nason and Lockhart said creation of a new independent regulator would remove HUD from the process of approving new loan programs, setting housing goals, and oversight of Fannie Mae and Freddie Mac.

Copyright 2008 Inman News



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