Should there be a cap on compliant loan limits?

In November, the Federal Housing Finance Agency announced its annual change to the compliant loan limit for loans purchased by Fannie mae and Freddie mac (GSE). For 2022, the limit was announced to have increased 18% to $ 647,200, reflecting the average increase in home prices over the past year.

But the compliant loan limit does not apply in the same way to the whole country: from 2008, some “high cost” areas could see loans issued up to 150% of the baseline, which is equivalent to $ 970,800 in 2022.

As these loan limits approach $ 1 million, Don Layton, principal investigator at the Joint Center for Housing Studies at Harvard University, argues that this raises a fundamental policy question: “Should GSEs, which finance mortgages on favorable terms due to large taxpayer subsidies, do so for the benefit of families wealthy enough to carry a million dollar mortgage? “

To answer this question, Layton breaks down the systems that lead to the setting of compliant rate limits by asking five questions to better inform the debate.

1. Although a million dollars is an eye-catching number, the base and high-cost area ceiling calculations simply reflect the extremely high growth in house prices in recent years, which seems to be exactly the way the system works. loan limit should work. So wouldn’t any reduction in limits be a conclusion of the American owner?

“When you only look at compliant loan limits, that’s a valid point of view. However, these limits do not exist in isolation, and the totality of factors determining the extent to which the government supports and subsidizes home loans have shifted to push the percentage of new mortgages funded by the four government agencies to high levels in recent years. years, ”Layton wrote. “More specifically, the combined market share of the four agencies averaged nearly 55% from 2001 to 2003, which is considered a relatively normal period not distorted by the bubble that had just started. More recently, the share averaged around 70% from 2014 to 2019, when bubble burst dislocations were mostly in the past, and so this higher percentage seemed to represent a ‘new normal’ .

“This significant increase in market share stems primarily from the collapse of the private label (i.e. non-government backed) securitization market, which has become particularly uncompetitive after its weaknesses were overcome. revealed in 2007-08, and secondarily by a lower allocation of bank balance sheets to first-rank mortgages. . Interestingly, this loss of market share was almost entirely replaced by the FHA and VA, not the GSEs, in part because the loan limits of the former increased relative to the latter after the break-up. of the bubble.

“This 70% range is an extraordinarily high level and I don’t think it was ever considered when the 2008 legislation revised the compliant loan limit system. Therefore, it can be reasonably argued that a reduction in limits is an appropriate and easy to implement policy lever to force the market share of government agencies to partially or fully fall back to 50%, resulting in a decrease in government subsidies. taxpayers for more expensive housing. . “

2. While a reassessment is an interesting idea, given that the loan limits used by GSEs (as well as the FHA and VA) are enshrined in legislation, can it lead to a real review without Congress? does pass new legislation, which is an unlikely outcome at the moment?

“This is a widely held opinion,” Layton wrote. “However, in 2013, when the FHFA was headed by interim director Edward DeMarco, he obtained an opinion from the legal staff of the FHFA that the agency, acting as the curator of the two GSES, could set limits of loan less than the requested formula. in legislation, but never higher. While this was never implemented, it is clear that a reassessment could produce a review without congressional action. However, given that the FHFA lost its regulatory independence last June via a Supreme Court ruling, this now means the Biden administration is pulling the blows against the GSEs, as it is already doing at FHA and VA. Therefore, the administration should be in favor of such a reduction and it is not clear that it would be. When it comes to reducing FHA or VA limits, unfortunately, legislation is probably needed. “

3. Given the politicization of the US housing finance system, would a proposed revision of GSE loan limits survive lobbying from influential economic and ideological interest groups, or would it be a waste of time and effort? efforts ?

“Over the years, I have heard senior FHFA officials express their frustration with the process of obtaining public comment on any proposal, as it is usually dominated by the ‘usual suspects’ expressing long predictable views. dated. I would mainly expect this to be true in this case: (i) Conservative think tanks would strongly support a reduction in GSE limits in line with their long-held view that any reduction in the GSE footprint is a good idea. ; (ii) the mortgage banking industry (banks and non-banks) would oppose any reduction in limits as this would result in less profit for their members, although there may be differing views from some bank lenders, and (iii) the private sector the label securitization industry (PLS) would be in favor of a reduction because it would lead to more volume passing through its hands and therefore to more profits.

But Layton goes on to say that the much more liberal views of housing advocates and the current administration are a little harder to predict.

“On the one hand, they should be in favor of lower limits so that GSEs subsidize the upper middle class less (i.e. by reducing the ‘welfare of the rich’), which would allow companies to focus their energy and grants more on low and moderate income borrowers (LMI). On the other hand, GSEs subsidize the price of their mortgage purchases, as higher balance loans produce part of a subsidy pool which is then used to reduce the mortgage interest rate to borrowers. LMI; as such, liberal housing advocates might not support a limit reduction as it would reduce this pool of available grants. “

4. What about the FHA? Should his loan limits also be reassessed?

“The FHA loan limits only partially mimic those of the GSEs. Basically, the FHA sets a loan limit for each specific geographic area (primarily counties) at 115% of the local median sale price of homes. There is a floor on the minimum level of the limit, which is equal to 65% of the GSE benchmark loan limit (now $ 420,680) and a ceiling set on the GSE high cost zone limit (now 970 $ 800). Thus, the FHA is clearly focused on its target market of LMI borrowers, which is appropriate and does not appear to need reassessment. “

“However, the maximum (for the limited number of eligible geographies) is still close to $ 1 million, which seems particularly questionable given that the raison d’être of the FHA is to focus on first-time buyers. property and families with more marginal solvency. This requires reassessment of whether these high balance borrowers deserve the large taxpayer subsidy (which is even greater than that enjoyed by GSEs) contained in all of the FHA’s mortgage financing activities.

It should be noted that Alaska, Hawaii, Guam, and the Virgin Islands have higher loan limits as required by law. These special limits are set at $ 1.5 million. These special deviations should be taken into account in any overall reassessment of the current limits.

5. Likewise, should there be a change in the way the VA limits the amount of mortgages it insures?

“The VA works much like the FHA in the way it finances mortgages, except that some features are more generous for veteran borrowers (for example, don’t allow any down payment, against the 3.5% minimum. FHA) as a means for Congress to provide fringe benefits to their military service. “

In 2019, Congress enacted the Blue Water Navy Vietnam Veterans Act of 2019 which removed the upper limit on VA guaranteed loans, meaning there is now no limit on how much a veteran can withdraw. for a house, always without down payment.

“It’s curious and difficult to understand. For the small number of veterans who become wealthy enough to afford such large mortgages (potentially millions of dollars), is it really good public policy for the taxpayer to subsidize them without limit, even with respect to their service? military? I know a few rich veterans and I don’t see any of them supporting such a grant for themselves. And it would undoubtedly be a scandal if it became publicly known that a very wealthy veteran received, say, a $ 5 million no-down mortgage loan subsidized by taxpayers through the VA. So a reassessment should include imposing a dollar limit on the size of VA mortgages, and it might even be generous to reflect that it is designed to be of benefit to veterans.

Layton concluded that with the upper loan limit reaching $ 1 million, now is the perfect time to review and reassess loan limits, but sees no drastic changes likely.

“Instead, I see that there is a narrow window for a few modest but well-chosen revisions within the existing framework: (i) for GSEs, either reduce the limits modestly (eg 20%) or institute a cap (to a number less than $ 1 million), while protecting the majority of cross-subsidies that go to IMT borrowers; (ii) for FHA, have a similar reduction or cap; (iii) for GSE and the FHA, reduce some of the special treatment accorded to Alaska, Hawaii, Guam and the Virgin Islands; and (iv) for the VA, cap the now unlimited amount allowed, but at a generous level to reflect the fact that its borrowers are veterans.

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