A proposal by the Securities and Exchange Commission could hurt the struggling housing market by eliminating mortgage real estate investment trusts (REITs) as an important loan-financing source.

REITs are exempt from the Investment Act of 1940 that regulates corporations. Most importantly, REITs are exempt from the act's leverage limits. If the SEC ends the exemption, as proposed, REIT profits will suffer and their contribution to home loan financing will be severely constrained, experts warn.

With home values down, private financing sources limited, and Fannie Mae, Freddie Mac and banks struggling with foreclosures, REITs are a small but important source of funding for the struggling housing market, they say.

"If the SEC were to regulate (mortgage REITs), to make their strategies unprofitable or unable to generate the necessary returns, they would be stanching a good bit of the flow of private capital to the housing and housing finance markets," Rich Eckert, an analyst at B. Riley & Co., told National Mortgage News.

"This exemption has serious implications for mortgage REITs in terms of leverage, legal liability, capital raising and hedging," analyst Jason Stewart of Compass Point Research & Trading LLC wrote in a note to clients this month, also according to National Mortgage News.

"REITs, which borrow money in short-term markets to buy mortgages and mortgage-backed securities, have become a pillar of U.S. mortgage finance as restrictions on banks and Fannie Mae and Freddie Mac’s capital have tightened," notes the Financial Times.

The SEC says it is concerned that the exemption raises the possibility for abuses, such as misvaluation of company holdings, over-leveraging and over-reaching by insiders.

The agency is accepting public comments on its proposal.