Economist Warns Fannie and Freddie Headed For More Trouble

Trading Markets.com reports on Fannie and Freddie's higher loan limits:

Dean Baker, co-director of the Center for Economic and Policy Research in Washington, says the change could cause Fannie Mae and Freddie Mac to become overexposed to the nation's most overpriced housing markets. If prices continue to fall in places like California and Florida, Fannie and Freddie could face huge losses and, in a worst-case scenario, might require a taxpayer bailout.

"Are we getting them to buy mortgages that are good risks but banks just don't realize it, or will they be buying bad risks that banks are appropriately deciding not to take?" Baker asks. "If it's the latter, they could get into big trouble."

His worries may sound far-fetched at the moment, because Fannie and Freddie have been mostly untouched by the subprime mess. It's precisely because of their financial strength that the housing industry wants them to enter the so-called "jumbo" loan market, where interest rates have soared as other lenders have tried to cut their exposure to housing.

Keep in mind, however, that Fannie and Freddie just recently finished cleaning up multibillion-dollar accounting scandals that surfaced in 2003 and 2004. Congress talked about tightening the regulation of the companies after that, but it hasn't gotten around to doing anything.

"We got into this mess because we didn't have a good regulatory structure," Baker said. "You shouldn't want them to expend in a market they're not familiar with when you still don't have the right regulatory structure in place."

Other people are less critical of the expansion. Alex J. Pollock, a resident fellow at the American Enterprise Institute, said he would have liked to see the higher loan limit accompanied by regulatory reform, but he thinks the measure could help calm panicky credit markets.

Pollock emphasized, though, that the $730,000 loan limit should remain temporary. It's designed to expire in a year.

Trouble is, the housing market probably won't turn around that fast. Does anyone believe that the housing industry will let the limit fall back to $417,000? Lobbyists will predict disaster, and Congress will oblige with a series of one-year extensions. In all likelihood, we've permanently raised the ceiling on mortgages that Fannie and Freddie can buy.

In moderately priced housing markets like St. Louis, that actually may be bad news. These companies' capital and resources aren't infinite. "If they go more into the high end, there's less capacity available for the lower end," Baker pointed out. "Congress approached it as if there's this free lunch, this big pot of money available. You haven't made the pot any bigger; you've just stirred it around."

Essentially, Congress is gambling that it can turn the housing market around by throwing money at it. If that turns out to be a losing bet, both taxpayers and homeowners will be poorer for it.

Fannie and Freddie sure have a lot of Congress on the pad.