Rate cut, stimulus plan could restart housing

By Lynn Adler - Analysis

NEW YORK (Reuters) - A hefty Federal Reserve rate cut and a stimulus plan that would expand the availability of home loans may reinvigorate the beleaguered U.S. housing market and help the broader economy along with it.

The Federal Reserve's interest rate cut of three-quarters of a percentage point at an emergency meeting last week spawned a series of events that left mortgage rates at their lowest level in nearly four years.

Meanwhile, pent-up demand for high-priced homes could be met if, as outlined in a U.S. fiscal plan unveiled last week, the limit on conforming loans Fannie Mae and Freddie Mac can buy is raised as much as 75 percent for a year. The two companies are federally mandated to keep mortgage funds flowing.

The two events could stabilize a beleaguered housing sector that has hacked away more than 1 percentage point from economic growth, professors and economists said. With housing on the mend, the mood of the consumer will improve, helping set the U.S. economy back on track.

"The increase in the conforming loan limit should have a positive impact on the housing market, and overall I would say the package is large enough that it should have a notable impact on GDP growth," said Dean Maki, chief U.S. economist, Barclays Capital in New York.

The downside is that these measures help the most credit-worthy borrowers and not those already in trouble.

In fact, more financing from Fannie Mae and Freddie Mac will likely only stimulate sales of pricier homes.

The current $417,000 limit prevents borrowers with good credit in expensive areas from getting larger mortgages at a time when the jumbo market is all but shut down.

The plan being touted by President George W. Bush and the House of Representatives hikes the limit to $729,750 through 2008, and lifts the cap on loans insured by the Federal Housing Administration indefinitely to the same amount from $367,000.

Raising the loan purchase size for government-sponsored mortgage funding companies, however, gives scant aid to borrowers with the credit problems that initially sparked the housing downturn.

"What the economic stimulus package does, and the accompanying housing provisions do, is really lower the cost of credit to credit-worthy borrowers," said Nicolas Retsinas, director of the Joint Center for Housing Studies at Harvard University, and a Freddie Mac (FRE.N) board member.

"Today's problem is access to credit for credit-impaired borrowers and people falling behind on their mortgage payments. This does not release the chokehold to credit impaired borrowers," he said. "At best, this certainly should put the brakes on a further deterioration of the housing market."

Another potential roadblock to recovery is that the characteristics of mortgage bonds would change as the new larger loans are issued, leading traders to potentially exact a premium for added interest-rate risk.

The two federally chartered companies keep funding for mortgages flowing by buying home loans, repackaging them into bonds and selling them to investors.

Borrowers with large, jumbo loans are more likely to refinance since their savings are greater for each incremental drop in rates than for a smaller loan. Faster prepayments would reduce the market value of the bonds, especially when interest rates fall.