Two changes at Fannie Mae and Freddie Mac (the GSEs)–the raising of conforming loan limits to $729,750 from $417,000 and the lifting of previously established portfolio growth caps–are part of a recent measures by Congress and OFHEO designed to help the housing market. These moves have attracted significant debate regarding their ultimate impact on mortgage market liquidity and whether they will soften the severe credit issues facing the housing industry. Unfortunately, we do not believe the impact will be material. Limited Geographic Benefit

Nevada, Arizona, and Florida–three of the hardest hit states to which builders have an average 32 percent exposure of deliveries–all had low levels of non-conforming loans as a percentage of total loans in 2007. Since most loans were already conforming, we do not believe raising the limits will materially help these markets. We estimate 10 percent of Nevada's loans don't conform, with Arizona and Florida both in the 5–8 percent range (national average: 11 percent). Only California–where public builders in our coverage universe have an average 15 percent exposure–had the highest non-conforming percentage, at 35 percent.

What's more, on an overall national basis, JPMorgan estimates only 30–35 percent of the total outstanding non-conforming loans would qualify under the new conforming limits.

Capital Constraints

We believe lifting the portfolio growth caps is a moot point, as the GSEs remain highly capital constrained. Moreover, OFHEO noted it will discuss the "gradual decreasing" of the 30 percent capital surplus requirement with the GSEs, the timing of which will be influenced by the GSEs' financial condition and overall risk profiles, as well as current market conditions.

Accordingly, we believe this will occur gradually–over a minimum of several quarters, and more likely years, particularly in light of OFHEO's track record of a very cautious approach to the GSEs over the last three to four years. Additionally, we note that the GSEs' capital bases are still absorbing losses, with Fannie reporting quarterly net losses of $1.6 billion and $3.5 billion in 3Q07 and 4Q07, respectively, while Freddie's losses during those periods were $2.0 billion and $2.5 billion.

We expect material write-downs to continue to occur over the next six to nine months, likely resulting in more losses, stemming from Fannie's holding of $70 billion of subprime and Alt-A mortgages, and Freddie's $100 billion of subprime mortgages. Lastly, we note that even if the GSEs could apply $1 billion of unused capital toward buying mortgages for their portfolios, this could only be used to purchase $29 billion of loans using the 345 basis point capital ratio requirement, or only 9 percent of the total $340 billion newly eligible pool of loans, according to JPMorgan estimates.

Poor Secondary Market

While GSEs are required to set aside a minimum amount of capital to guarantee loans–only 45 basis points of capital for every $1 guaranteed–a counter-party is still needed to purchase the mortgage. Given the large write-offs and shrinking balance sheets of the large investment banks and money centers–the very same who were the primary buyers of mortgages in the past decade–we would not anticipate large demand currently for this product, despite the GSE guarantee being attractive.

–Michael Rehaut is an executive director of JPMorgan. He may be reached via e-mail at [email protected].