The economic crisis has been unprecedented in many ways, but the latest news concerning Fannie Mae and Freddie Mac takes the cake. The mortgage refinance companies are considering issuing refinanced loans without home value appraisals.

The government is eager to halt the downward slide of the housing market, but with their latest proposal, they're moving beyond market reality. Fannie Mae and Freddie Mac, the mortgage finance companies seized by the government this past fall, are considering issuing a mortgage refinance to the typical homeowner without requiring home value appraisals.

Strange mortgage refinance remedy

Times are tough for homeowners. This latest proposal, however, seems completely incongruent with market forces. Under the proposal, a homeowner could get a mortgage refinance without an appraisal. If you bought a house with a $280,000 mortgage, and it's currently worth $130,000, Fannie and Freddie would still allow the loan. In the past, this type of mortgage refinance would have been laughed at, because no one could get a loan if he was upside-down on his mortgage.

The message from the government seems to be that you can abide by the rules of the marketplace when times are good, but change them when times are bad. The ramifications for this action could be enormous. How would these types of loans be valued? What's the point of having an appraisal, which guarantees fair market home value? Without some sort of valuation standard, the concept of a home mortgage that uses property as collateral would cease to exist.

Skipping appraisals, skirting the law

The reason behind the strange new policy is that by doing away with appraisals, Fannie and Freddie could skirt some of their restrictions on loan financing. At present, they're prohibited from financing a loan if a borrower holds less than 20 percent of the equity in his property without mortgage insurance.

FHA loans have already begun to overtake Fannie Mae and Freddie Mac because they don't have such stringent home equity requirements. However, financial experts are already questioning the rationale of simply handing out these types of loans without any concern for fiscal realities. The government is eventually putting itself in a similar position to that of the many subprime lenders who filled their books with bad loans. Eventually, the system won't be able to handle so much bad paper.

Too little, too late?

There's little doubt that the American economy is reeling after the decline of the housing market, and the subsequent subprime mortgage fiasco. But the government's reaction to the slumping market seems to be a case of too little, too late.

The time for corrective action should have been during the time of irrational homeowner exuberance, when the typical residence was over-priced and lenders ignored the fundamentals of their trade. The government didn't apply the brakes during this period, because both lenders and homeowners were happy. Now, both parties are feeling severe pain. Unfortunately, this latest proposal has the potential to provide a short-term band-aid, but create a long-term illness that will be hard to cure.

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Published on January 19, 2009