We Don’t Need to Raise Conforming Loan Limits

The scuttlebutt on the Hill is that members of the House are seriously considering wavering on whether or not to raise conforming loan limits. The limits refer to the max sized mortgages that Fannie Mae or Freddie Mac can purchase and/or securitize. In the years leading up to the housing crisis, when the GSEs were encouraging large loans to high risk borrowers, the max sized loan they could buy was $417,000 (with a few exceptions for high cost regions). In an effort to use the GSEs to prop-up the housing market, that cap was raised to $729,750. At the end of September, Congress allowed the cap to fall to $625,500, still well above the historical cap and supporting very large mortgages. But the Senate has decided to attach returning the conforming loan limit to its $729,750 maximum as a condition on getting a necessary spending approval bill through Congress.

This is ridiculous. And I was about to list out all the reasons why on this blog, but my friend Ed Pinto has summed up the reasons so well over at The American that it is easier just to dump his text here:

1) The loan limits fell with no significant impact on the housing market. In the short time since the loan limits were lowered, there has been no real evidence of adverse impacts on the housing market. To the contrary, the pace of home sales actually increased in September, despite the fact that lenders had already begun conforming to the lower loan limits back in July. Furthermore, the Federal Reserve reported recently that the lower limits would have impacted about 3 percent of purchase mortgages last year. This does not mean these loans would not have been made: Many of these high cost homes could have been financed at somewhat higher rates or with a larger down payment.

2) While the housing lobby presents this issue as “now is simply not the time,” the real question is: if not now, when? The housing lobby has resisted commonsense reforms for many decades. Let us not forget that Fannie and Freddie collapsed in 2008. For 15 years the housing lobby’s efforts to stop reform allowed these too-big-to-fail entities to spread moral hazard around the world. Congress needs to focus on fundamental reform and end its fixation on subsidizing rates by 0.25 or 0.5 percent. Just over the last 12 months mortgage rates have varied by 1 percent. Stop focusing on the trees when the entire forest is at risk as a result of the nationalization of housing finance.

3) The proposal to raise the Fannie/Freddie/FHA loan limits is using data from before the burst of the housing bubble. For example, the Menendez amendment would calculate local FHA loan limit maximums using a formula based on 2008 area median home prices. However, home prices have dropped dramatically since that time (17-23 percent), meaning those loan limits simply do not reflect the current state of the market. This poses a particular risk for FHA given its much riskier loan profile. For example, the average down payment on FHA loans used to purchase a home is about 4 percent. Add the fact that over the last two years an estimated 20-25 percent of FHA’s dollar volume has been from California. Raising FHA’s limit ensures that FHA can continue to use government backing to insure home loans that are well beyond the size of an average home.

4) Senators are blocking the Obama administration’s goal of reducing the government’s footprint in the housing market. The Senate vote puts it at odds with the Obama administration, which has repeatedly called for the federal government to shrink the size of its footprint on the national housing market. In its February white paper, the administration called for the reduction of loan limits as part of the greater effort to allow “private capital to play the predominant role in housing finance.” In the paper, the administration recommended that Congress allow the temporary increase in limits to expire as scheduled and as a result, “larger loans for more expensive homes will once again be funded only through the private market.” The private sector responds to market needs, but this is virtually impossible if the government continues to crowd out any private competition.

5) The FHA is already dangerously overextended. FHA’s market share of total originations going into the crisis was only about 2.5 percent. Now, its market share has ballooned to approximately 30 percent. Moreover, FHA’s third-quarter fiscal 2011 report to Congress showed that its Capital Reserve Account has been drained from $19.6 billion just two years ago to a low of $2.8 billion at the end of June 2011 due to rising defaults.

See Ed’s full post here.

See my original post on the Menendez/Isakson bill in the Senate here.

And see my commentary from earlier this year on what role lowering conforming loan limits can play in starting the housing finance reform process.