Housing Market Stimulants

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Last week, the Bush administration issued two remedies for a badly ailing housing industry: a provision in the stimulus package for Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE) to begin (temporarily) accepting so-called jumbo loans, and a plan called Project Lifeline that will delay foreclosures.

Cynics liken these policies to giving cough drops to a pneumonia patient. However, to more optimistic observers, they will provide a much-needed inducement for the market to heal itself.

Banks can help
Project Lifeline stipulates that the six banks holding approximately one-half of the nation's mortgages -- Bank of America (NYSE: BAC), JPMorgan Chase (NYSE: JPM), Countrywide (NYSE: CFC), Washington Mutual (NYSE: WM), Citigroup Inc. (NYSE: C) and Wells Fargo (NYSE: WFC) -- will give a 30-day pause (a lifeline) in the foreclosure process to borrowers who are delinquent by 90 days or more, creating a window of opportunity for borrowers to renegotiate terms.

This won't solve the problem. Most of those who are foreclosed upon simply cannot afford the property. A delay in the foreclosure process or a tweak in the loan terms won't entirely change that fact. However, it won't do any harm, and it will prevent some foreclosures.

Call in the mortgage cavalry
Of far greater impact is the economic stimulus package signed last Wednesday, which includes provisions for Fannie Mae and Freddie Mac to accept larger loan amounts. Fannie and Freddie are federally chartered corporations that don't lend money to homebuyers directly. Rather, their role is to purchase loans, conforming to certain guidelines, from originating lenders in the secondary market. The new provision increases the maximum mortgage loan amounts that FNM and FRE will buy from lenders from $417,000 to $729,750.

Why this matters
The new Fannie and Freddie jumbo loans are a huge inducement for more business because they make it more attractive for lending institutions to give such loans. Jumbo loans can now be easily sold in the secondary market, which enables lenders to recover the money and have it available for more loans and, also, escape the risk of holding loans on their own books.

Also, mortgages that conform to Fannie's and Freddie's underwriting standards have their guarantee and, although FNM and FRE are private companies and are not obligations of the U.S. government, they enjoy the implied backing of the government and the corresponding lower rates. (Jumbo loans in an average market were typically priced about 0.25% higher than conventional loans, and now, in this market, they've been about 1% higher.)

So, in one fell swoop, new home purchases in the crucial high-end sector become a much more desirable proposition for both the borrower and the lender in an anemic housing market that desperately needs more activity.

Will this fix the housing market problems? No. Why? Because the main problem is that housing prices are still too high and it's a terrible economy. The policy won't change that. But it can help.

We are in the midst of the worst housing slump in 25 years. Pending home sales are the second lowest on record. Lenders in this market have been reluctant to issue jumbo loans that can't be sold to FNM and FRE. But few things prime the economic pump like housing starts. And that goes double for expensive housing starts. In 2007, about 15% of all mortgages originated were jumbo loans. This new policy could grow that number substantially.

What's the verdict?
One could argue that these policies are useless and only good for giving political cover to politicians who need to make it appear that they've done something. However, this Fool thinks the government has actually done a pretty good job. It can't wave a magic wand and fix everything. The government isn't, nor should it be, in the business of bailing out the market. Politicians are, however, in the business of setting the stage for an environment where the market can more easily bail itself out. That they've done. Good for them.

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