The Debate on Whether to Raise Conforming Limits Continues.

The beleaguered MBS market got a reprieve from its problems last week, after Fannie Mae Chief Executive Daniel Mudd heard proposals from OFHEO Director James Lockhart and HUD Secretary Alphonso Jackson to raise the OFHEO-imposed cap on GSE portfolios and raise the conforming loan limit of $417,000 for single-family homes in the lower 48 states.

Reacting favorably to the news, the market pulled mortgage spreads tighter, on the theory that the measure would boost the ability of GSEs to support the loan market. The agencies might also offset this increase by issuing callable debt, which these GSEs hedge partly by using swaptions.

Mere speculation that the OFHEO might lift the portfolio caps on the GSEs could boost the MBS market in the short run, according to Barclays Capital …