By John W. Schoen Senior producer
updated 11/8/2007 6:51:10 PM ET 2007-11-08T23:51:10

As Congress and the financial services industry struggle to cope with rising mortgage defaults and a deepening housing slump, Federal Reserve Chairman Ben Bernanke Wednesday proposed that the federal government guarantee so-called “jumbo” home loans worth up to $1 million.

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Bernanke proposed that so-called “government sponsored entities” like Freddie Mac and Fannie Mae pay mortgage insurance fees to the federal government. These GSEs would then guarantee loans that are larger than the current $417,000 limit on so-called “conforming” mortgages.

“From the federal government's point of view, (the GSEs) would be taking on some credit risk, which you may or may not be willing to do,” Bernanke told members of the Joint Economic Committee in a question-and-answer session.

Bernanke also said that the final cost of the mortgage market meltdown might ultimately reach the level of losses from the savings-and-loan debacle of the late 1980s. Rep. Kevin Brady, R- Texas, asked if estimates of $150 billion in losses are “in the ballpark of what you estimate to be eventually declared.”

“That's in the ballpark,” said Bernanke. “Though I would emphasize that there's no reason to think that that would all be in financial institutions.  It's spread around to a lot of investors of  different types.”

The issue of raising limits on so-called “conforming” loans has been debated on Capitol Hill as the housing boom has lifted home prices, especially in high-cost markets. With mortgage lenders and investors tightening up on credit, home buyers looking to borrow more than  $417,000 are finding it harder — and more expensive — to get a mortgage.

“The result is that those mortgages are still available, but at somewhat tighter terms and higher prices than otherwise,” Bernanke said.

While a number of proposals are being considered in the House and Senate to help borrowers facing default and head off additional losses to lenders and investors, Bernanke said he was note aware of provisions in any of those bills that would guarantee these "jumbo" loans.

In response to a question from Committee Chairman Sen. Charles Schumer, D-N.Y., Bernanke suggested that mortgages eligible for government guarantees be capped at $1 million.

“I think that's a very good idea,” Schumer said of the guarantees. “In fact, legislatively, it's  something that I would try to introduce and get passed.”

Schumer introduced a bill last month that would allow Fannie Mae and Freddie Mac to raise their total loan portfolios by 10 percent for six months. Bernanke suggested the new guarantees on jumbo loans should also be temporary.

A bill on GSE reform was passed by the House in May, but it has not yet come before the Senate.

Freddie Mac and Fannie Mae bundle pools of home mortgages, chop them up into securities and resell them to investors. Though not explicitly backed by tax dollars, these mortgage pools are considered less risky by investors. That tends to keep interest rates lower than on “jumbo” loans above the $417,000 cap.

Congress has looked at the idea of raising the cap, but opponents have cautioned that doing so could add more risk to the portfolios of Fannie and Freddie than they are currently set up to handle.

Though Bernanke's proposal was short on details, it apparently would overcome that opposition by putting an explicit federal guarantee on loans of up to $1 million. By making these guarantees temporary, the proposal would also overcome opposition to putting taxpayer dollars permanently in harm's way if these loans default.

Supporters of increased caps argue that the loan limits have not kept up with home prices in some parts of the country, such as New York and California. Opponents argue that raising the limits would increase the risk that the government would have to make good on loans that default.

Congress is also working on proposals to try to head off a wave of mortgage foreclosures as borrowers who took out loans with low “teaser” rates find themselves unable to meet higher payments as their adjustable rates reset. Many of them had been advised they could refinance to a fixed rate before those resets took effect. But with housing prices falling, the opportunity to refinance for some is limited.

Bernanke said that on average about 450,000 subprime mortgages will reset to higher rates each quarter through the end of 2008, or a total of nearly 2.5 million. He also said the number of foreclosures resulting from these resets can be reduced if financial institutions work with borrowers.

Bernanke said the Fed plans to issue a proposal by the end of the year that would create new standards and rules for all lenders that issue subprime loans, which are mortgages provided  to borrowers with weak credit histories, generally at above-average rates.

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