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Are There No Limits To Financial Fiddling?
By Peter G. Miller
July 3, 2007

At the start of every year, and with the regularity of celebrations in Times Square, new conforming loan limits go into effect.

Typically such loan limits are announced in November or December, go up each January and in general that's good for buyers and sellers. This year the conforming loan limit for a single-family home is $417,000 (and 50 percent higher in Alaska, Hawaii, Guam, and the U.S. Virgin Islands).

If a loan is "conforming" it means lenders can easily sell such mortgages on the secondary markets to such buyers as Fannie Mae, Freddie Mac and others. Since they're easily to sell, lenders like to make such loans which means they are relatively easy for borrowers to get. If a loan is above the conforming loan limit then, whoops, it's a "jumbo" loan and borrowers will need to pay more interest.

For some buyers and sellers it actually makes sense to postpone a late-year home sale until after January 1st if conforming loan limits are about to rise. If needed financing is too big for the old limit, but just right for the new on, then buyers who delay a few days or weeks can reduce financing costs or borrow more.

Under the Housing and Community Development Act of 1980, the new conventional loan limit is supposed to reflect average home prices as of the 12-month period which ends each prior to October. Typically this means that the conventional loan limit is increased, but not always.

  • In 1990 the conforming loan limit was reduced by $150 from the 1989 level because home prices declined 0.07 percent.

  • In 1994 the conforming loan limit remained unchanged even though the index had declined 2.96 percent in 1993.

  • In 1995, the conventional loan limit was again unchanged despite a 1.46 drop in the 1994 index.

  • In 1998 the index rose 8.44 percent but the loan limit was only raised 3.67 percent.

  • In 2004 the conforming loan limit rose 3.41 percent -- even though regulators said the limit should only go up by 2.71 percent.

  • In 2007, the conventional loan limit remained unchanged from 2006 even though home prices had actually declined by .16 percent or about $700.

You get the picture. The conforming loan limit changes with some disregard to what actually happens to home prices.

Because of "safety and soundness concerns about the annual adjustment to the conforming loan limit," the Office of Federal Housing Enterprise Oversight (OFHEO) -- the federal entity that oversees Fannie Mae and Freddie Mac -- now wants to know by July 19th if the system should be revised.

The responses are going to be fairly predictable.

Those who believe in "statistical sanctity" will want the loan limit to exactly reflect home price changes. Others will argue no harm, no foul, just keep the present ad hoc system in place.

In fact the current system is harmful. It allows conforming loan limits to be raised at a time when property values in many markets are in decline. This means borrowers in some cases will be able to get more loan money than they should, lenders will be able to make bigger conventional loans than might otherwise be possible and investors will be able to buy loans with more risk than they might anticipate.

This is somewhat fine and wonderful until a borrower is foreclosed and the security for the loan -- the property -- has insufficient value to cover lender or investor losses.

Artificially swollen loan limits, by themselves, will not cause a massive number of foreclosures or financial losses. However, when you add bloated loan limits to all the other junk that's polluting the mortgage system, you get a brew that harms the public interest and fails every measure of safety and soundness.

If it's okay for regulators and the mortgage industry to twist requirements and standards, what sort of message does that send to borrowers and loan officers? OFHEO plainly says that loan limits have been adjusted "in a manner that is different from the survey results." Is it then okay to "adjust" loan application data in a manner that's different from reality?

Here's a concept: How about taking annual home price changes and adjusting conventional loan limits accordingly? Regulators would not have to revise anything, they would merely have to follow existing standards