Freddie Mac has entered the market for jumbo loans, or loans of more than $417,000. That could be good news for some borrowers, but also means U.S. taxpayers are taking on additional risk.
Freddie announced last week that it expects to finance between $10 billion and $15 billion of jumbo loans this year. Some borrowers won't even need the 20% down payment -- the mortgages can be used to finance up to 90% of a property's value.
The same day,
said it had been buying jumbo loans since the beginning of the month.
In January, the Economic Stimulus Act temporarily raised government sponsored enterprises (GSEs) loan limits from $417,000 to 125% of the area median home prices, allowing Fannie Mae and Freddie Mac to back loans of more than $700,000 in the most expensive areas.
At first, the Office of Federal Housing Enterprise Oversight had balked.
"It's going to lessen
Fannie and Freddie's ability to meet their affordable housing goals," OFHEO Director James B. Lockhart told the Senate Banking, Housing and Urban Affairs Committee in a February hearing. "And, you know, a jumbo mortgage takes three times as much capital as their normal mortgage. So that's a concern to us."
But just over a month later, OFHEO lowered the GSEs' capital reserve requirements from 3.25% to 3.0%, freeing up money for the GSEs to buy, among other things, jumbo loans. In exchange, the groups agreed to raise more capital to buy, among other things, jumbo loans.
By all accounts, GSEs were already awash in risk. Fannie and Freddie both lost billions last year. Last week's OFHEO report to Congress is littered with references to the GSEs' high and increasing credit risk. The lowered capital reserve requirement also increased risk: It had originally been put in place in 2004 to reduce operational risk after accounting scandals and was lifted as credit risk exploded.
Just how much more risk are the already risk-ridden GSEs -- and thus the taxpayers -- taking on?
Apparently, no one's figured out how to measure it, but "a lot" is an excellent bet.
In the first place, regulators may know Fannie and Freddie are in a risky business, but, even without jumbo loans, they don't seem to have much of an idea of how risky their portfolios are.
"Given the lack of historical precedent for current conditions and the fact that models are estimated based on historical experience, enterprise models have become less reliable and require greater management judgment, increasing the potential for error in pricing and other metrics," the OFHEO said in last week's annual report to Congress.
And then there are the specific problems of measuring jumbo-loan risk, which is also hard to quantify because the GSEs have never dealt with it before.
So basically, in a very risky environment they're taking on an unknown -- but likely high -- amount of extra risk.
In addition, the prices of houses that require jumbo loans are likely to keep right on falling: If the run-up in housing prices was purely a bubble, the national market will still fall another 30%. But the prices won't drop evenly, but instead will be largest in the areas with the biggest run-ups in housing prices.
Those are precisely the areas where the GSEs will increase their loan limit: Over 50% of the loans will be in California, according to OFHEO.
If owners of multimillion-dollar properties can't handle their mortgages and decide to walk away, taxpayers have a problem.
The GSEs and federal home-loan banks hold over $1 trillion more debt than the federal government's publicly held debt.
wouldn't allow the failure of
; there's no way it could allow the failure of these goliaths, either. So they have little incentive not to take on increased risk: If, by some miracle, the jumbo loans prove profitable, shareholders -- and homeowners with six-figure salaries -- gain. Should jumbo loans serve only to temporarily prop up an already bursting bubble, taxpayers lose.
The possibility of a government bailout puts the risk squarely on our shoulders. And with risk management mostly in private hands -- the legislation was pushed through before the OFHEO could be given more meaningful regulatory powers -- it may be a heavy burden.