Bernanke cautions on raising GSE loan limit

By Patrick Rucker

WASHINGTON (Reuters) - Federal Reserve Chairman Ben Bernanke warned Congress on Thursday that increasing the size of loans mortgage companies Fannie Mae and Freddie Mac can buy could be problematic and would help only if done swiftly.

Bernanke said if Congress were to raise the so-called conforming loan limit imposed on the two government-sponsored enterprises, or GSEs, from its current $417,000, lawmakers should move swiftly enough to ensure the effort serves its intended purpose of easing strains in the mortgage market.

In recent weeks, the two companies and their allies in Washington have called for regulators to let Fannie and Freddie buy larger loans to stabilize the shaky mortgage finance sector. Bernanke said in comments prepared for delivery to Congress that such a move could expose the government to the risk of covering those loans if they fail, since investors view Fannie and Freddie as having government-backing.

"If, despite these considerations, the Congress were inclined to move in this direction, it should assess whether such action could be taken in a way that is both explicitly temporary and able to be implemented sufficiently promptly to serve its intended purpose," Bernanke said in testimony prepared for delivery to the U.S. House of Representatives Financial Services Committee.

Bernanke said any rise in the loan limit should be decided swiftly, because markets would be disrupted as investors weigh the chances of Fannie and Freddie buying more large loans.

The Fed chairman also warned that expanding the loans Fannie and Freddie can buy would wrongly give an implied government backing to those investments and increase risk to investors, government and the companies.

"The perception, however inaccurate, that the GSEs are fully government-backed implies that investors have few incentives in their role as counterparties or creditors to act to constrain GSE risk-taking," Bernanke said.

"Raising the conforming-loan limit would expand this implied guarantee to another portion of the mortgage market, reducing market discipline further," he added.

Bernanke said subprime mortgage disclosures triggered a series of events leading to far broader turmoil in financial markets and risks to the economy as a whole.

"The resulting global financial losses have far exceeded even the most pessimistic estimates of the credit losses on these loans," he said, echoing an assessment he made at a monetary policy conference in August.

The Fed, in mid-August, stepped in with a surprise cut to the discount rate -- the interest rate it charges banks for loans -- in an effort to revive credit markets, which had seized up as investors became unwilling to assume risks.

Earlier this week, the Fed took the additional step of lowering the federal funds rate, which governs overnight loans between banks, by a hefty half-percentage point. The rate is the U.S. central bank's main tool for influencing the economy.

"The action was intended to forestall some of the adverse effects on the broader economy that might arise from the disruptions in financial markets and to promote moderate growth over time," Bernanke told lawmakers on Thursday.