Federal Reserve Board chairman Ben Bernanke told a key House leader this week that any move to raise the limit on the value of mortgages that Fannie Mae and Freddie Mac can buy should only be temporary.
In a Sept. 17 letter to House Financial Services Committee chairman Barney Frank, Bernanke also defended the current cap on the ability of the two mortgage securitization and investment companies to buy up mortgages.
While this position is at odds with demands of many House Democrats, Bernanke also pledged the Fed would do what it can to mitigate the ongoing crisis in the mortgage market.
"Progress in this area will require sustained effort not only by the Congress and by state and federal regulators, but by lenders, servicers, and community groups as well," Bernanke wrote.
"The Federal Reserve will continue to play an active role in this process."
On the issue of whether Fannie and Freddie should be able to buy larger mortgages, Bernanke said this should be done carefully.
He said many market participants see Fannie and Freddie as fully government-backed entities, and allowing the companies to buy higher-priced mortgages would extend an "implied guarantee to another portion of the mortgage market."
"If the Congress is inclined to move in this direction, it should consider whether such action could be taken in a way that makes the change explicitly temporary as well as promptly implemented, lest it inhibit private securitization activity in the interim," Bernanke wrote.
On the portfolio caps, Bernanke said the risks to the two government-sponsored enterprises (GSEs) are not credit risks, but interest rate risks, and that these risks "loom especially large because the GSE portfolios are so big."
He said also reminded Frank the caps imposed by the federal regulator were meant to limit growth in these portfolios until accounting problems are resolved at both companies.
"In the longer term, in my judgment, both the size and the composition of the portfolios should be tied to reforms that both reduce the systemic risks posed by the portfolios and also clarify their public purpose," he said.
Bernanke's letter was sent just days before he is scheduled to testify before Frank's committee tomorrow, and is a response to Frank's September 7 letter to Bernanke.
In that letter, Frank said he thinks the portfolio caps for Fannie and Freddie need to be expanded in order to buy sub-prime mortgages and bring liquidity to that troubled sector of the market.
Frank rejected Bernanke's idea that Fannie and Freddie should "make room" for subprime mortgages by selling of other mortgage holdings, and said this approach would force both companies to dilute the quality of their holdings.
However, Bernanke said in his letter this week that Fannie and Freddie "probably could accommodate some sub-prime borrowers within the conditions of their charter and (consequently) without increasing their overall credit risk."
Bernanke also cautioned that the GSEs should not take on riskier subprime mortgages that "do not meet the credit-quality requirements imposed by their charters."
The federal regulator for Fannie and Freddie today slightly expanded the portfolio caps in order to allow the purchase of more sub-prime mortgages, but not by an amount Democrats see as significant.