This morning, President Bush signed into law a broad housing bill, The Housing and Economic Recovery Act of 2008, Pub. L. No. 110-287,1 which provides an array of support for home borrowers, including a mortgage re-financing program under the Federal Housing Administration (FHA) and additional assistance to and regulation of the government-sponsored enterprises (GSEs) involved with housing. The Housing Act was passed as H.R. 3221 by the House on July 23 and by the Senate on July 26. There is no conference report. Overall, the Housing Act is effective immediately, although implementation will require substantial administrative action in the next few months.
The Housing Act is unchanged from the bill described in our advisory of July 23, 2008,2 but a few observations are in order regarding the practical implications of the FHA refinancing program and about the other substantial tasks now facing Treasury, HUD, the Federal Reserve Board and other federal departments and agencies.
HOPE for Homeowners Act
The foreclosure prevention centerpiece of the Housing Act is the HOPE for Homeowners Program. This program will enable distressed borrowers who have shown the willingness and some capacity to repay to refinance out of burdensome mortgage loans that are or may soon be in default and into an FHA-guaranteed, 30-year fixed rate mortgage loan. The program takes effect October 1, 2008, and will run for three years. FHA is authorized to guarantee up to $300 billion in such loans and the guarantees will be financed through HOPE Bonds issued by Treasury. In order for the program to take effect as promised, Treasury, HUD and FHA will have considerable work ahead of them in the next two months, including structuring the bond program and writing regulations that will govern participation in the program.
The program is not mandatory, however, and presents significant questions about whether the program will produce the borrower benefits that Congress expects. The owner of an existing loan — typically represented by a servicer — must agree to release existing liens in order for any refinancing to occur. Given the nature and amounts of the existing loans, a servicer who participates almost invariably will cause investors to take a loss. That is, the proceeds received by the servicer in the refinancing will be less than the outstanding balance of the original loan. The duties of loan servicers to the owners of or investors in the loans are currently governed both by contract and doctrines of fiduciary duty in state common law. While the contracts and state common law may vary, a servicer must, as a general proposition, maximize value and avoid losses. For loans in default or in danger of default, the investment contracts between servicers and investors can be structured to favor foreclosure over loan refinancing or modification. A servicer’s participation in the program thus may create liability concerns.
To address these concerns, Section 1403 of the Housing Act creates a limited “safe harbor.” Under the safe harbor, a servicer is deemed to have acted in the best interests of investors if the servicer participates in a modification or HOPE refinancing of any loan where (i) default has occurred or is reasonably foreseeable; (ii) the borrower occupies the property securing the mortgage; and (iii) the anticipated recovery on the principal outstanding obligation under the modification or refinancing exceeds, on a net present value basis, the anticipated recovery through foreclosure. This safe harbor is potentially useful, although a servicer will have to undertake a complex, presentvalue comparative analysis. More problematical, however, the first sentence of the safe harbor provision begins: “Except as may be established in any investment contract between a servicer of pooled residential mortgages and an investor ....” This exception may prove to be a significant hurdle to servicer participation in the program. Typically, investment contracts do not give servicers the ability to modify the terms of a mortgage loan where the modification would result in the reduction of principal. As a result, for servicers under existing contracts, the safe harbor would be inapplicable. Moreover, to the extent there is more value in foreclosure, a servicer will be required to seek that remedy.
Other Rulemakings and Administrative Actions
Full implementation of the Housing Act will require several executive departments and independent agencies to make substantial and complicated decisions, including some potentially extensive rulemakings. Banks, thrifts and other participants in the mortgage industry thus will have nearterm opportunities to weigh in on many actions that will affect them. Among the decisions required are the following:
- Financial support for Fannie Mae and Freddie Mac. Although Treasury is not required to issue rules about support for Fannie and Freddie, either through equity investments or debt instruments, it now will have to make a continuous series of closely watched decisions about when and how to step in. Importantly, Treasury support is not strictly unilateral. Fannie and Freddie each effectively must consent to Treasury purchases, and they will have a particularly complicated set of decisions on possible dilution as a result of any equity investment.
- Creation of the Federal Housing Finance Agency. This new agency — FHFA — will replace both the current Fannie Mae and Freddie Mac regulator, the Office of Housing Enterprise Oversight, and the Federal Housing Finance Board (FHFB), which oversees the Federal Home Loan Banks (FHLBs). The current administration must set up FHFA now, including the appointment (with Senate confirmation) of a director. In the interim, the current director of OFHEO, James Lockhart, will run FHFA. (There is also an oversight board, whose members include the FHFA director, the secretaries of Treasury and HUD, and the chairman of the SEC.) FHFA will succeed to the functions of both agencies, as well as to certain housing3 related functions that HUD now performs, and will absorb appropriate staff from HUD, OFHEO and FHFB. FHFA is required to finalize capital rules for the GSEs within 180 days — that is, by January 27, 2009. Before issuing these rules, or most other rules of substance, FHFA must consult with the Federal Reserve.
- Housing Goals. FHFA must set single-family and multi-family housing goals for Fannie and Freddie, which are measured in connection with the loans that both entities purchase, for the years 2010 and forward. Both Fannie and Freddie currently are subject to the 2008 goals that already have been set by HUD, and FHFA has discretion to retain the 2008 goals in 2009 or to issue new goals (subject to a public comment process). FHFA also has certain enforcement authority if Fannie or Freddie fail to meet their housing goals. FHFA may also set housing goals for the FHLBs.
- Interest Rate Disparities. No deadlines are imposed, but FHFA has authority to request data from Fannie and Freddie in order to determine whether there are disparities between comparable minority and non-minority borrowers with respect to the interest rates on comparable mortgage loans. If FHFA preliminarily finds such disparities exist in loans by a particular lender, it must refer such finding to the lender’s appropriate regulator. FHFA must report to Congress annually on its interest-rate disparity inquiries.
- Securities Registration by the GSEs. The Housing Act takes away certain exemptions from registration that Fannie and Freddie previously had enjoyed under the Securities Exchange Act of 1934. Freddie registered its common stock on July 18 and its various series of preferred stock on Monday; Fannie registered its common and preferred shares yesterday. Additionally, all of the FHLBs are required to register a class of common stock by November 28 of this year. • Housing and Community Development Funds. Both HUD and Treasury have responsibilities here. HUD must establish a Housing Trust Fund and an accompanying program that will make grants to state and local governments to support both rental and home ownership programs for low-income families and individuals. Treasury must establish a Capital Magnet Fund as part of its community development activities, which fund is intended to attract investment in affordable housing and related facilities. Both funds will be financed by statutorily required contributions from Fannie and Freddie. The FHFA has some discretion to suspend contributions in times of stress. In the first three years, some of the contributions by Fannie and Freddie may be used to reimburse Treasury for payments on the bond program that will finance the FHA’s HOPE for Homeowners Program.
- Mortgage Licensing. In an attempt to provide certain baseline requirements for statelicensed loan originators and yet to leave most regulation at the state level, the Housing Act encourages the Conference of State Bank Supervisors and the American Association of Residential Mortgage Regulators to develop a Nationwide Mortgage Licensing System and Registry. Mortgage originators remain required to comply with state licensing laws. If a state has not adopted certain minimum requirements within two years, HUD is authorized to impose a back-up registration system in that state. In the meantime, the federal banking regulators must ensure that employees of their regulated institutions meet comparable requirements and are registered with the nationwide system.
- FHA Modernization. The Housing Act amends — and largely expands — FHA’s powers in areas beyond the refinancing of distressed mortgage loans. The terms of FHA-insured loans are changed in several respects, including lifting the ceiling on the principal amount of an eligible loan, down payments, premiums and the eligibility of condominium and manufactured housing loans. As a result, FHA will have to revise existing guidance in several respects.
- Reverse Mortgages. The Housing Act also amends FHA’s authority to insure home equity conversion mortgages, a form of a reverse mortgage. Lenders of this product must be able to show that borrowers received appropriate counseling about the risks associated with the product and are prohibited from requiring a borrower to use the proceeds of the loan to purchase investment or other products from the lender. These changes will require material changes in the FHA’s rules and policies on reverse mortgages.
- Service member Protections. The Department of Veterans Affairs must implement changes to VA-backed mortgage loans to service members and veterans, while the Department of Defense must put in place a home ownership and foreclosure prevention counseling program for active-duty military personnel.
- Truth in Lending Act. The Housing Act makes several amendments to the Truth in Lending Act relating to mortgage loan disclosures. The Federal Reserve Board, which is responsible for Regulation Z (implementing truth in lending requirements), published regulations today that should conform to these amendments.3