Housing finance changes likely to mean less government backing for some buyers

By Zachary A. Goldfarb and Brady Dennis
Washington Post Staff Writers
Friday, February 4, 2011; 12:08 AM

The Obama administration is likely to recommend reducing the size of mortgages eligible for government backing, according to current and former officials, a move that could make getting a home loan in high-priced areas such as the Washington region more expensive.

Administration officials, who are preparing a white paper on overhauling the nation's housing finance system, are looking at scaling back the support provided during the mortgage crisis to help the ailing real estate market.

In the District and most of its neighboring counties, home buyers have benefited from a temporary federal policy that has allowed mortgages up to $729,750 to receive government backing. Such home loans typically carry lower interest rates than those without government support, because investors are attracted by the official guarantee.

The administration is now likely to suggest that Congress allow the policy to lapse as scheduled in September, lowering the loan limit to $625,500.

The proposal to let the higher limits lapse is among the most concrete elements in the long-awaited review, which examines various options for reshaping the role government plays in the mortgage finance market.

The report, which will in part address the fate of the troubled mortgage giants Fannie Mae and Freddie Mac, is scheduled to be released as soon as next week.

The white paper comes in response to one of the prime causes of the financial crisis - a breakdown in the system that funnels money to home buyers. The collapse of Fannie Mae and Freddie Mac, which sit at the heart of that system, has proved to be the most expensive legacy of the crisis. The government seizure and rescue of the firms in September 2008 has cost taxpayers more than $130 billion.

At the same time, the companies have been essential cogs in the home loan market, providing billions of dollars in funding to keep interest rates low at a time when most private financial firms have abandoned the mortgage finance business.

The review is still being debated by policymakers at the White House, the Treasury Department and the Department of Housing and Urban Development, according to sources familiar with the discussions.

"These discussions are ongoing, but the president has not made decisions on any policy options," said a White House official, who like others interviewed for this article spoke on the condition of anonymity to comment on internal talks.

The report's release has already been delayed twice, attesting to the economic and political challenges confronting its authors.

The housing market is still in the doldrums, and any significant policy changes could have a major impact on the affordability of housing. Changes could also affect economic relations between the United States and other countries, for instance China and Japan, because of their large holdings of securities backed by American home loans.

Meanwhile, the new Republican majority in the House has been sharply critical of the Obama administration's handling of the housing policy review, saying the White House is reluctant to announce a plan for abolishing Fannie and Freddie and devising a new housing finance system. Many Republicans say Fannie and Freddie played an outsize role in causing the financial crisis.

The administration is not expected to lay out a detailed blueprint for a new housing finance system, sources said. Instead, officials are expected to announce short-term steps to slightly reduce government support, such as by dropping loan limits. The administration's hope is that banks would feel more comfortable offering loans for higher-priced homes without government support.

The Washington region and other pricey housing markets have a three-tiered mortgage system. The lowest rates apply to 30-year fixed-rate mortgages that do not exceed $417,000 and meet Fannie Mae and Freddie Mac guidelines. The highest rates apply to loans larger than $729,750, also known as jumbo loans, which are not guaranteed by the federal government. An in-between rate can be found for loans from $417,000 to $729,750.

Guy Cecala, publisher of Inside Mortgage, said there's little doubt that lenders are eager and able to jump back into the jumbo loan market, and many have. The problem is that the private market imposes tough standards for borrowers taking out these large loans, demanding 30 percent down payments and credit scores above 750.

"That could change if there's more competition within the private sector, but we don't know that yet," Cecala said.

Keith Gumbinger, a vice president at mortgage research firm HSH Associates, said he expects that borrowers who took out loans between $625,500 and $729,750 would pay "slightly more expensive rates" if the current proposal is enacted, "but jumbos were always slightly more expensive."

At least at first, reducing loan limits would not have much effect in parts of the country that have more moderately priced real estate markets.

The report may discuss at least two options for a long-term overhaul of the housing finance system. One option would severely scale back government support for housing, leaving only the Federal Housing Administration, which targets first-time home buyers. Another option would be to create a government backstop for housing.

Both policies seek to address a fundamental problem posed by Fannie and Freddie in the buildup to the housing crisis. Chartered by Congress as corporations, Fannie and Freddie grew beyond their means as investors thought they carried an implicit guarantee of governmental support and were too big to fail. Meanwhile, Fannie and Freddie, as profit-making corporations, took ever-bigger risks. In the end, the hybrid system led to disaster.

The lack of a consensus within the administration about which option to advocate reflects ongoing differences among policymakers. Treasury Secretary Timothy F. Geithner and his advisers have expressed skepticism about a continued large role for the government in providing support for housing.

But other powerful and rarely aligned interests - such as the financial industry, civil rights organizations and groups that advocate for affordable housing - support a continued role.

"The essential question is: Is there going to be a government guarantee beyond FHA? That's one central area of debate," said Michael Barr, who recently stepped down as a senior Treasury official. "Both sides agree that if there is a government guarantee, it needs to be an explicit government guarantee, and it needs to be paid for."

Administration officials say any steps they take will be gradual.

"You have to make sure other people are coming" into the market as the government exits, said an administration official. "You don't want to leave a hole in the market where credit-worthy borrowers can't get any credit. The government is guaranteeing 95 percent of the market. It's not like it's just going to stop tomorrow."

One idea under discussion is to create a government insurance fund for mortgages. Banks would make home loans, and a new mortgage insurance company would charge a fee to insure the loan. Then the new government fund would charge a second fee to provide another layer of insurance. If the loan went bad, the government insurance fund would cover the loss only if the private mortgage insurance company had collapsed.

Peter Swire, who helped oversee mortgage finance policy at the National Economic Council earlier in the Obama administration, said a government guarantee is necessary because the government will still be on the line if the housing market crashes.

"My reading of history is when the housing system is tanking in any major economy, governments have intervened," said Swire, a law professor at Ohio State University. "We'll get all of the problems of an eventual government rescue without the safeguards."

goldfarbz@washpost.com dennisb@washpost.com

Staff writer Dina ElBoghdady contributed to this report.

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