Fix GSE Loan Limits--in All Markets

Resident Fellow Alex J. Pollock
Resident Fellow
Alex J. Pollock
The latest GSE reform bill, HR 1427, has passed the House of Representatives and is presumably headed for consideration by the Senate. Meanwhile, Fannie Mae and Freddie Mac are moving back toward business as usual.

I believe the creation of a combined regulator for Fannie, Freddie, and the Federal Home Loan banks, as the bill provides, is a good idea whose time has come. It makes sense to have a single perspective from which to oversee the trillions of dollars of government-sponsored debt and mortgage-backed securities issued by the three government-sponsored enterprises.

But the bill would not cut back on the GSEs' fundamental government-granted competitive advantages, which deliver implicit subsidies to their shareholders. The special government status of their debt and their lines of credit with the Treasury would be left intact, while the conforming loan universe would be expanded.

The fundamental idea is that in high-cost areas, Fannie and Freddie should be limited to mortgages for houses costing about 125 percent of the median or less.

In addition, Fannie and Freddie would become the source of a large government affordable housing program. Therefore, one key result of the bill would be to promote the financial market's belief that the GSEs are even more closely tied to the government than before--to reinforce their government-supported status, and to reduce market discipline even further, despite increasing regulation.

Fannie and Freddie did have their accounting scandals. They have had severe embarrassments, replaced their managers, and are out a couple of billion dollars to pay for restating their accounting records. (The scandals appear to be one of the all-time great profit opportunities for accounting firms.)

But the global debt markets don't mind. With current financial statements or not, Fannie and Freddie debt and securities continue to sell at narrow spreads and top credit ratings.

Even when the GAAP financial statements are finally brought up to date, the market knows that they will be opaque and largely meaningless, anyway, because of FAS 133. However, this won't really matter, because for the fixed-income markets, the real issue is the comforting presence of the government's credit, which the GSE reform bill would make even more comforting.

Another key result of the bill would be increased market share for Fannie and Freddie, because of the increased conforming loan limits for "high-cost areas." In these areas (however defined), the limit would rise from the current $417,000 to the median price for a house in the area. The maximum would be 150% of the general conforming limit, so under current circumstances, the maximum would be $625,500--moving a good bit of what is now the private "jumbo" loan market into GSE-dominated turf.

Note that this would be a maximum loan amount, so for an 80% loan-to-value mortgage, Fannie and Freddie would be financing a house costing about $780,000. It is an interesting piece of logic to take the median price and turn it into a loan limit. For an 80% LTV loan, the house being financed at the limit would have a price of 125% of the median.

The fundamental idea is that in high-cost areas, Fannie and Freddie should be limited to mortgages for houses costing about 125% of the median or less. They would not be allowed to finance more expensive homes (except in the case of low-LTV mortgages).

This seems a reasonable principle, but why should it apply only to high-cost areas? We could apply it everywhere and define the conforming loan limit as the area median price--with a floor of 50% of the current conforming limit, to match the 150% maximum. Under current circumstances, the minimum would be $208,500, close to the national median price, so low-cost areas would be protected.

This would make symmetrical the asymmetrical provision of HR 1427. It would emphasize that Fannie and Freddie are supposed to be operating more or less from the middle of the market down--everywhere. The "middle of the market" would be defined as houses costing about 125% or less of the area median.

This would be a straightforward way to redefine the conforming loan limit so that it matched market conditions in all areas.

Though unworkable 70 years ago when the limit was invented for savings and loans, this system would be easy with today's information technology.

As the Senate takes up GSE reform once again, it should consider how to counterbalance the effects of making the GSEs' ties to the government even stronger than before.

Alex J. Pollock is a resident fellow at AEI.

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About the Author


Alex J.
  • Alex J. Pollock is a resident fellow at the American Enterprise Institute (AEI), where he studies and writes about housing finance; government-sponsored enterprises, including Fannie Mae, Freddie Mac, and the Federal Home Loan Banks; retirement finance; and banking and central banks. He also works on corporate governance and accounting standards issues.

    Pollock has had a 35-year career in banking and was president and CEO of the Federal Home Loan Bank of Chicago for more than 12 years immediately before joining AEI. A prolific writer, he has written numerous articles on financial systems and is the author of the book “Boom and Bust: Financial Cycles and Human Prosperity” (AEI Press, 2011). He has also created a one-page mortgage form to help borrowers understand their mortgage obligations.

    The lead director of CME Group, Pollock is also a director of the Great Lakes Higher Education Corporation and the chairman of the board of the Great Books Foundation. He is a past president of the International Union for Housing Finance.

    He has an M.P.A. in international relations from Princeton University, an M.A. in philosophy from the University of Chicago, and a B.A. from Williams College.

  • Phone: 202.862.7190
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    Phone: (202) 419-5212

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