Mortgage Giants Aim to Reduce 'Jumbo' Rates

Fannie Mae and Freddie Mac argue for lifting the $417,000 limit on home loans they can buy.
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Fannie Mae (FNM) and Freddie Mac (FRE) think they can do what the Federal Reserve can't: lower the interest rates on residential mortgages.

While the Fed can cut only short-term interest rates, the two government-sponsored enterprises provide cheap, long-term financing for homeowners by purchasing their mortgages from banks. The loans are then repackaged and resold to investors.

But the mortgage giants are currently restricted from purchasing mortgages above the $417,000 limit on loans that conform to government guidelines. This pushes up rates on mortgages greater than $417,000, known as jumbo loans, because they are harder to sell to Wall Street firms.

The difference, or spread, between interest rates on jumbo and conforming mortgages widened sharply over the summer as uncertainty about the quality of loans made investors skittish about buying anything not guaranteed by Fannie or Freddie. As of last week, consumers were paying 92 basis points more on jumbo fixed-rate 30-year mortages than on conforming fixed-rate 30-year mortgages, according to data from HSH Associates.

By comparison, at the beginning of the year, consumers were paying less than 20 basis points more of interest on jumbo rates. (A basis point is a hundredth of a percentage point.)

The 50-basis-point cut in the federal funds rate Tuesday hasn't helped. As I wrote

here earlier this week, mortgage rates tend to track yields on 10-year Treasuries. A survey of large lenders by Bankrate.com Wednesday shows the average interest rate on a 30-year, $165,000 mortgage actually rose slightly to 6.32% from 6.28% a week earlier.

Allowing Fannie and Freddie to purchase bigger loans would make cheaper financing available to more people, particularly in places such as California where prices remain high, even as the number of bad loans mounts.

In the past, some people in high-cost areas have taken out two separate, smaller loans to avoid paying jumbo rates, but lenders have become much less willing to issue second mortgages.

The spike in jumbo rates is creating pressure in Congress to loosen the reigns on Fannie and Freddie by allowing them to purchase bigger loans, at least temporarily. Fannie and Freddie went on the offensive at a House Financial Services Committee hearing Thursday. CEO Richard Syron said lifting the conforming-loan limit would spark more buying and selling of jumbo loans and thus bring down rates. He noted that the difference between conforming-loan and jumbo-loan rates is bigger than it has been in the past 20 years.

"In high-cost areas in particular, a temporary lifting of the conforming loan limit might prevent declines in house prices that could lead to additional defaults," Syron said in prepared testimony.

Fannie Mae CEO Daniel Mudd also said he would support an increase to the limit on conforming loans to help the market for jumbo loans, but he said he would leave it to Congress to determine the level.

Raising the conforming loan limit could also help borrowers with impaired credit refinance out of expensive adjustable-rate mortgages into cheaper fixed-rate loans. Fannie and Freddie buy a limited amount of subprime mortgages, but the Federal Housing Administation and the Veterans Administration, which do cater to subprime borrowers, also face restrictions on the size of loans they can guarantee. And these limits are pegged to the $417,000 cap on loans Fanne and Freddie can buy.

If Congress doesn't act, the conforming loan limit is likely to remain unchanged for at least the next year. It is based on year-over-year changes in a house-price index published by the Federal Housing Finance Board, which is on track to decline slightly for the second year in a row.

Fannie and Freddie are also lobbying for increases in the amount of mortgages they can hold in their investment portfolios.

On Wednesday the Office of Federal Housing Enterprise Oversight, the companies' primary regulator, agreed to relax restrictions on Fannie Mae's investments. Its new policy allows the company to grow its portfolio by 2% a year.

But having the flexibility to grow the portfolio by 10% would allow Fannie to boost liquidity invest in more loans to people who are refinancing out of unaffordable subprime mortgages, Mudd said in his prepared remarks on Thursday.

The Bush administration has previously tried to have stronger regulatory oversight of Fannie Mae and Freddie Mac. But Treasury Secretary Henry Paulson signaled a change in stance at the hearing on Thursday.

"There is little question that allowing

Fannie Mae and Freddie Mac to securitize jumbo mortgages would give a short-term lift, which would be helpful to a segment of the housing market that has shown some recent improvement but is not functioning as normal," he said in his prepared remarks.

Paulson said, however, that any change should be temporary, and he didn't endorse Fannie Mae's and Freddie Mac's requests to increase their portfolios beyond regulatory limits.

Allison Bisbey Colter joined TheStreet.com in 2006 from the New York office of Dow Jones Newswires, where she spent the previous seven years covering consumer finance, mutual funds and hedge funds. Prior to that, she worked in Europe for Dow Jones covering transportation from London and Italian capital markets from Milan. She is a graduate of Wesleyan University, where she received a BA in government.