The Fannie and Freddie Meltdown: Picking Up PACE
On September 6, 2008, the nation’s two largest housing government-sponsored enterprises (GSEs), Fannie Mae and Freddie Mac were taken under conservatorship by the U.S. Treasury.
At the time, then-Treasury Secretary Henry Paulson stated that “conservatorship was the only form in which I would commit taxpayer money to the GSEs.” He further said that he attributed the need for the action “primarily to the inherent conflict and flawed business model embedded in the GSE structure, and to the ongoing housing correction.”
The GSEs now own or guarantee three-quarters of the nation’s mortgages and since the Treasury Department stepped in, taxpayers have been forced to pump $145 billion into them with no predictable end in sight. Yet the recently enacted financial services reform bill is utterly mute on the fate of these mortgage monsters. The 2,300-page bill addresses financial regulatory minutiae down to the nano detail, but leaves taxpayers in the dark about what plans, other than constant infusions of tax dollars, the administration and Congress have in mind to resolve Fannie and Freddie.
In the meantime, the White House is supporting yet another twisted scheme that will foist additional risk onto the two broken GSEs and, ultimately, the taxpayers. The new program is the Property Assessed Clean Energy loan program, or PACE.
The PACE program’s origins are vague, but it appears to be the brainchild of a group of hedge fund managers. A solar financing blog offers a video tutorial on the program and discusses its provenance this way: “It all started with Berkeley and the ‘Berkeley First Program.’ A company called Renewable Funding developed a system for financing home solar energy systems and energy efficiency improvements by partnering with a city and adding the cost of the solar systems or improvements onto the homeowner’s property tax bill, amortized over twenty years. The program was absurdly popular when it launched, and now, about a year later, cities are starting to run pilots of this program left and right.”
Under PACE, homeowners would be permitted to borrow money from their local governments to retrofit their homes with energy-efficient improvements such as solar panels, high-efficiency furnaces, etc. They would then repay the loans over a long period of time, up to 20 years, through a special add-on to their property tax bills. Local governments would be permitted to issue bonds to raise the money to make the loans.
The problem arises in the event that the homeowner defaults and the home goes into foreclosure, a rather common occurrence these days; PACE loans would skip to the front of the line for repayment because they would be considered tax liens, which are usually senior to existing property debt. Mortgage bankers, as well as Fannie Mae and Freddie Mac, would be summarily relegated to a secondary position. PACE poses serious threats to the GSEs’ financial stability, which right now is shaky at best. A July 27, 2010 Wall Street Journal article reports that new foreclosures on properties backed by Fannie Mae and Freddie Mac increased sharply, rising 21 percent from May to June, 2010.
PACE ushers in a deluge of unintended and unattractive consequences, serious downsides for homeowners, the mortgage market, Fannie and Freddie, and ultimately, the taxpayers. Hedge fund investors may be thrilled, but “consumers stand forewarned,” says the Consumer Mortgage Coalition’s (CMC) Executive Director Anne Canfield. “This is the 2010 version of the predatory ‘Tin Men’ loans of the 1960s.” According to Canfield’s group, it is no surprise that investors find the program attractive; as currently configured, the PACE program provides a generous 4 to 10 percent return on investment for the entire 20-year life of the loan, higher than rates on 30-year fixed mortgage loans, which hover between 4 and 5 percent. If the homeowner sells the home before the 20-year life of the loan expires, the balance of the PACE lien conveys with the property.
However, in an economic environment when property values are dropping dramatically, it doesn’t make sense for homeowners to increase the debt burden on homes that have depreciated in value or may already be underwater. “In one fell swoop, the PACE program will effectively violate the homeowner’s mortgage contracts. This will have a negative impact on all future homeowners seeking to refinance, as well as future homebuyers, as investors will need to factor in the fact that their existing property rights have been damaged. This program makes no sense for consumers, for communities, for anyone,” says Canfield.
According to a July 15, 2010 letter sent by the CMC to the Environmental Protection Agency (EPA), the Energy Department, and other agencies opposing the program, “PACE programs, as currently designed, put consumers at risk and could increase the cost of housing finance nationwide. These programs should be terminated before more consumers are put at risk and the nation’s housing finance system is fundamentally altered to the detriment of all those seeking to finance or refinance their mortgages.”
Canfield’s group is not alone in its opposition to the PACE program. The Federal Housing Finance Administration (FHFA), which currently has conservatorship over Fannie Mae and Freddie Mac, has not only vocalized opposition, it has announced that it will not allow Fannie and Freddie to purchase mortgages which have PACE loans attached, a move that has brought many of the PACE programs to a screeching halt for the moment.
Supporters claim that the program will help homeowners implement energy-efficient upgrades that are often too costly without long-term financing. However, there is no reliable way to quantify the savings that might be generated by a specific upgrade to a specific property or whether the renovation is cost effective in the long run. A March, 2010 Government Accountability Office (GAO) report stated that the Energy Star Program, a popular energy certification program jointly overseen by the EPA and the Energy Department, was “for the most part a self-certification program vulnerable to fraud and abuse.”
PACE critics argue that while energy-efficient homes are a worthy goal, there is no good reason to encourage homeowners to tap the equity in their homes to achieve energy efficiency, especially in the current economic downturn where the weakest sector is housing. One of the prime characteristics of the mortgage crisis was that many homeowners took advantage of loose capital standards and exotic loan instruments to use their home equity as a piggy bank for extraneous consumer spending. “It’s got all the right economics to take off in a huge way and then cause huge losses,” said David Felt, a retired senior FHFA lawyer. “When you’re able to market to people who can’t get financing for an ordinary home-equity loan, that should set off alarm bells.”
Critics also point out that there are no requirements to ensure that borrowers can repay their loans. The Department of Energy has issued loose guidelines for how to administer the PACE program. Cities and localities that are struggling just to manage garbage pick-up or pay firefighters have neither the budgets nor the expertise to enter the loan underwriting business for energy-efficient renovations to private homes.
At least 16 states, including Texas, New York, and California (which also has one of the highest foreclosure rates in the country and dramatically declining property values), have enacted PACE programs.
California Attorney General and Democratic gubernatorial candidate Jerry Brown has filed a lawsuit against FHFA for issuing the tough new guidelines for Fannie Mae and Freddie Mac. PACE supporters have also turned to Congress for intervention. Rep. Mike Thompson (D-Calif.) and 29 other members of Congress have cosponsored legislation to override FHFA’s protective guidelines, in effect forcing Fannie and Freddie to purchase mortgages that will further endanger their safety and soundness, as well as the taxpayers.
Tom LaMalfa, President of TSL Consulting, a mortgage research and consultancy and co-author of the Holm Mortgage Finance Report said, “One must wonder where such vacuous ideas originate… I’m not against energy conservation, to the contrary, but trying to advance such a program by making it a ‘tax’ and bestowing super lien status is beyond stupid. The potential problems raised are considerable and will negatively affect mortgagees to the point they will likely red line areas that advance the program.”
FHFA should hold firm on its new rules barring Fannie and Freddie from accepting mortgages with PACE loans attached.
