The Hair of the Dog

The stimulus package’s tax rebate has gotten the publicity, but many in the Bay Area are eyeing another provision more intently:

the tentative package - which still has several hurdles to clear - essentially rewrites the definition of "jumbo" loan, raising the cap from its current $417,000 to as high as $729,750 in high-cost areas for one year.

Mortgages below the jumbo loan limit are guaranteed by the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac). Fannie Mae and Freddie Mac are quasi-government agencies, and most believe that their guarantees---although this is nowhere explicitly stated---are as good as guarantees by the U.S. Government.

If lenders don’t want to hold the paper, they can flip below-jumbo (“conforming”) mortgages to other parties easily because the buyer is comforted by the implicit government guarantee. This proposal, if it passes, should arrest or at least dramatically slow the fall in real estate prices in California.

Other Notes:

1) Government guarantees prop up prices (related post below) in stocks, alternative energy, real estate, or whatever market we’re talking about. Using more government guarantees is using the hair of the dog to get us out of some of what put us in this mess in the first place.

2) The mortgage proposal will produce a break on the interest rate, but borrowers still have to pay back the principal. Still, the benefit can be significant. If the Chron article is accurate in its statement that the savings on a $650,000 mortgage are $417 per month, the total difference over a 30-year term will be $150,120. Compared to this annuity, the 2008 one-time tax rebate is a pittance.

3) One hopes that loan application procedures will be much tighter than they have been in the past six years. As one attorney noted last month,

fraud is everywhere. It's in the loan application documents, and it's in the appraisals. There are e-mails and memos floating around showing that many people in banks, investment banks and appraisal companies - all the way up to senior management - knew about it.

At least put a stop to this behavior going forward. How many got rich is enough to make an angry populist out of anyone.

4) Any time you have a significant financial boondoggle with an expiration date—in this case one year---the tax, legal, and financial experts start devising structures to extract the maximum benefit (for example, if your new, custom-built home won’t deliver until late 2009, someone will figure out how you can still get the benefit). Watch for the same people who gave us the subprime mess to start hawking products based on aspects of the stimulus package. © 2008 Stephen Yuen