Congress continued to make progress today on housing and on assistance to Fannie Mae and Freddie Mac when the House of Representatives passed the Housing and Economic Recovery Act of 2008 (H.R. 3221) by a substantial majority vote of 272 to 152. Today’s action was, in part, made possible by the withdrawal this morning of a White House veto threat relating to a $4 billion grant to local governments to facilitate purchases of foreclosed properties.
The House bill builds on the Senate’s July 11 approval of its own version of H.R. 3221 and on earlier proposals. Because the latest House bill differs in at least some respects from the Senate’s July 11 version, Senate approval will be required. A Senate vote may be scheduled as early as Friday, although some Republican Senators, including Senator Jim DeMint of South Carolina, may seek to block a vote. The political exigencies of a national housing crisis and a Presidential campaign nevertheless seem likely to force a Senate vote before the August recess beginning in two weeks. The Senate is scheduled to remain in session for two more weeks. If the Senate approves the measure, the President is expected to sign the bill into law shortly.
Both the version of H.R. 3221 that the House passed today and the Senate’s July 11 version are divided into three basic sections—GSE reform, foreclosure prevention, and related tax code changes. This advisory provides a broad summary of some of the more pertinent highlights of GSE reform and foreclosure prevention.1
Temporary Authority for Treasury to Invest in Fannie Mae and Freddie Mac, and to Extend Credit to the GSEs
The bill provides emergency authority to the Treasury Department to purchase obligations and other securities including both debt and equity securities directly from Fannie Mae and Freddie Mac, as well as in obligations of any of the 12 Federal Home Loan Banks (FHLBs), with the consent of the issuer. (We sometimes refer to Fannie Mae, Freddie Mac and the FHLBs collectively herein as the GSEs.) This authority to purchases securities would expire on December 31, 2009, and the amount of Treasury’s purchases would be limited by the federal debt ceiling. Credit made available under the House bill is in addition to the $2.25 billion of credit for both Fannie Mae and Freddie Mac currently authorized by law, though never drawn upon.
In exercising this temporary authority, the Secretary of the Treasury must determine that the purchase of securities is required (i) to provide stability to the financial markets, (ii) to prevent disruptions in the availability of mortgage finance and (iii) to protect the taxpayer. The Secretary is also required to take into consideration six factors in connection with exercising this authority:
- the need for preferences or priorities regarding payments to the government;
- limits on maturity or disposition of obligations or securities to be purchased;
- the GSE’s plan for the orderly resumption of private market funding or capital market access;
- the probability of the GSEs fulfilling the terms of any such obligation or other security, including repayment;
- the need to maintain the GSE’s status as a private company; and
- restrictions on the use of GSE resources, including limitations on the payment of dividends and executive compensation.
The Secretary of the Treasury is free to exercise any rights received in connection with the purchase of stock, and freely sell any stock, subject to the terms of the securities and at prices determined by the Secretary.
The Congressional Budget Office (CBO) estimates that there is a better than 50 percent chance that this authority would not be used before it expires at the end of 2009, but for budgeting purposes, CBO estimates the cost to taxpayers at $25 billion in 2009 and 2010.
Federal Housing Finance Agency
The bill abolishes the Office of Federal Housing Enterprise Oversight (OFHEO), which currently oversees Fannie Mae and Freddie Mac, and the Federal Housing Finance Board, which regulates the FHLBs. A new independent agency, the Federal Housing Finance Agency (FHFA), will replace both agencies.
Director and Funding. The bill requires the director of FHFA to be appointed by the President, and confirmed by the Senate to serve for a five-year term. The bill also creates three deputy directors, to be appointed by the director. FHFA would be independently funded through assessments on the GSEs and would not be subject to the annual appropriations process.
Federal Housing Oversight Board. A five-member Housing Finance Oversight Board would advise the director on overall strategies and policies. The board would be chaired by the director and include Secretaries of Treasury and the Department of Housing and Urban Development (HUD), or their designees, and two members appointed by the President and confirmed by the Senate. The board does not have the authority to approve or disapprove decisions or actions of the director.
Fannie Mae and Freddie Mac Boards. H.R. 3221 authorizes a reduction in the number of Fannie Mae and Freddie Mac board members, urging that number to be reduced to 13 from 18, and repeals current law giving the President authority to appoint some Fannie Mae and Freddie Mac board members.
Housing Missions. The bill alters the housing missions of Fannie Mae and Freddie Mac to meet goals to be established by FHFA for single and multi-family home purchasers in low income or very low income areas, which would be redefined at 50 percent of area median income (AMI). Both companies would be required to serve underserved markets, such as manufactured housing, affordable housing preservation, and rural areas. Currently, Fannie Mae and Freddie Mac are required to purchase mortgages for households representing three income levels, moderate income (100 percent AMI), low income (80 percent AMI) and very low income (60 percent AMI). The two companies are also directed to purchase mortgages in central cities, rural areas, and other underserved housing areas. FHFA may also establish housing goals for the FHLBs, bearing in mind the structural and overall mission differences between the FHLBs and Fannie Mae and Freddie Mac.
FHFA Regulatory Authority. FHFA’s primary duties would include:
- overseeing the operations of Fannie Mae, Freddie Mac, and the FHLBs;
- ensuring that each maintains adequate capital and internal controls;
- fostering a healthy national housing finance market that minimizes the cost of housing finance; and
- ensuring that each GSE complies with applicable regulations.
With regard to Fannie Mae and Freddie Mac, FHFA also will take over certain oversight duties performed by HUD.
H.R. 3221 further requires FHFA to establish regulatory standards that measure portfolio holdings with the goal of safe and sound operations for Fannie Mae and Freddie Mac, considering the size and growth of the mortgage market; the need for the portfolio to maintain liquidity or stability of the secondary mortgage market; the liquidity needs of Fannie Mae and Freddie Mac; and any other factors FHFA might determine to be appropriate. FHFA could also require Fannie Mae and Freddie Mac to dispose of or acquire any asset that it determines to be consistent “with the purpose of this Act.”
Among other powers, FHFA would be authorized to place the Fannie Mae and Freddie Mac into conservatorship or receivership and initiate corrective actions in the event of a financial crisis. With respect to either enterprise, FHFA would also have the authority to:
- reject any acquisition or transfer of a controlling interest;
- adjust risk-based capital standards;
- adjust minimum capital levels on a permanent or temporary six-month basis;
- establish capital or reserve requirements for specific programs or activities;
- take enforcement actions;
- prohibit or withhold executive compensation for wrongdoing; and
- review the reasonability and comparability of an executive officer’s compensation.
FHFA must be notified of any planned new activity by a GSE and would review and approve new programs within 30 days of a public comment period.
Federal Reserve Consultation. Under the legislation, until December 31, 2009, FHFA would be required to consult with the Federal Reserve before issuing any proposed or final regulations, orders, or guidelines regarding prudent management, safe and sound operations, and capital requirements and portfolio standards at the GSEs.
Corrective Actions. H.R. 3321 authorizes FHFA to establish a capital classification system for Fannie Mae and Freddie Mac similar to prompt corrective action (PCA) regime used by the federal banking agencies for depository institutions. The bill also specifies actions FHFA may take if Fannie Mae or Freddie Mac fall into one of the lower PCA categories:
- adequately capitalized – no corrective action by FHFA.
- undercapitalized – FHFA is required to monitor the condition of a Fannie Mae or Freddie Mac and compliance with capital restoration plans or other requirements. FHFA may also restrict the entity’s asset growth and prevent acquisitions of interests in other entities and new business activities without approval.
- significantly undercapitalized – FHFA is required to mandate a new election for a board of directors and selection of executives. The entity is prevented from paying bonuses or increasing salaries to their executives unless approved by the agency.
- critically undercapitalized – FHFA is required to establish a conservatorship or receivership to reorganize, rehabilitate or close the entity. FHFA could not revoke the charter of Fannie Mae or Freddie Mac.
GSE Conforming Loan Limits. The House bill authorizes FHFA to adjust the conforming loan limit according to the annual housing price index. The size of individual mortgage loans that Fannie Mae and Freddie Mac would be permitted to buy would increase to the lesser of 125 percent of an area’s median price or $625,000 (the current loan limit is $417,000). The economic stimulus law enacted in February included a parallel increase for loans originated between July 1, 2007, and December 31, 2008.
Portfolio Limits. The bill grants to the director of FHFA authority to issue regulations establishing portfolio limits for the number of mortgage loans that may be held by Fannie Mae or Freddie Mac in order to “ensure that the holdings are backed by sufficient capital and are consistent with the mission and safe and sound operations” of each enterprise.
Certain Federal Home Loan Bank Provisions. H.R. 3221 includes several specific provisions relating to the FHLB System. These include:
- Reducing to 13, from 14, the number of directors for each FHLB’s board. The existing geographic restrictions on board membership, which have on occasion proved problematic, will remain in place;
- Requiring independent directors (the counterparts to what are now the elected directors) be considered on the basis of the demographic make-up of the communities most served;
- Permitting two or more banks to establish a joint office;
- Requiring FHFA to create regulations to ensure that FHLBs have access to information needed to determine their joint and several liability;
- Permitting mergers between FHLBs, subject to approval by FHFA and each FHLB board; and
- Lifting the cap on director compensation, and extending director terms to four years.
Mortgage Foreclosure Prevention
Hope for Homeowners. The “HOPE for Homeowners Act of 2008” establishes a new program within the Federal Housing Administration (FHA) that would guarantee mortgages and help at-risk borrowers refinance their homes. These new mortgages would be offered by FHA-approved lenders that would refinance distressed loans at a significant discount for homeowners facing foreclosure. The legislation provides for the program to insure up to $300 billion in mortgages, with a target goal of assisting approximately 400,000 homeowners. The program would last for three years, commencing on October 1, 2008, and ending September 30, 2011. To qualify for participation in the program, all subordinated liens must be extinguished through negotiations with the first lien holder.
This program is guided by several policies: the promotion of long-term affordability; no investor or lender bailout; no windfall to borrowers; voluntary participation; and restoration of confidence, liquidity, and transparency in the housing market. The program has the following additional elements, but the benefits to borrowers whose loans are held in securitization pools may be doubtful.
- It is only available to homeowners who can prove they are unable to afford their current mortgage payments.
- The size of the new FHA-insured loan must be the lesser of the amount the borrower can afford to repay, as determined by the current affordability requirements of FHA or 90 percent of the current value of the home, and must have a 30-year fixed rate.
- In an effort to prevent any windfall, borrowers are required to share the equity and appreciation equally with HUD until the borrower sells or refinances the mortgage. If there is an equity gain as a result of a sale or refinancing within the first five years, then HUD is entitled to proportionally more on a sliding scale from 100 percent to 60 percent. We note that there has been a variety of other equity sharing proposals, some of which would create a secondary market in a kind of shared appreciation note or certificate. The bill does not specifically provide for secondary market transactions by HUD, but the Department may have implicit authority to do so.
The bill encourages loan servicers to participate in the new program by offering a liability safe harbor. Absent contrary contractual requirements, a servicer of pooled residential mortgages owes a duty to all investors to maximize the value of the pool and must act in the best interest of all investors. To modify a loan (1) default must be foreseeable; (2) the property must be occupied by the mortgagor; and (3) the anticipated recovery on the principal must exceed the anticipated recovery through foreclosure. The practical effect of this provision seems doubtful; many servicing contracts have contrary requirements that favor foreclosure over modification, so it is uncertain whether servicers may feel the safe harbor is available.
Mortgage Foreclosure Protections for Servicemembers. The bill also provides additional protections for servicemembers returning from active duty abroad by authorizing a temporary increase in the maximum loan guarantee by the Secretary of Veterans Affairs. The increased maximum is the higher of (i) 25 percent of the Freddie Mac limit for single family residences as of the year of origination, or (ii) 125 percent of the area median price for a single family residence. The bill would also amend the Servicemember Civil Relief Act by extending the period a lender must wait before starting foreclosure proceedings from three to nine months after returning from active service, and suspending mortgage interest rate increases in excess of 6 percent for one year after returning from active service.
Mortgage Disclosure Improvement Act. The bill includes the Mortgage Disclosure Improvement Act of 2008, which would amend the Truth in Lending Act (TILA) to expand the types of loans subject to early disclosure and improve loan disclosures provided at origination and refinancing. At least seven days prior to closing, mortgage loan terms would have to be disclosed, and changed terms would have to be disclosed at least three days before closing. Fines for TILA violations would increase from $2,000 to $4,000 per violation.
Assistance for Purchasers of Foreclosed Properties. The legislation would create a $7,500 credit for first time homebuyers that would serve as an interest-free loan to be repaid over 15 years. The House legislation provides for a deduction of property taxes of $500 for single filers and $1,000 for joint filers and also provides for additional tax incentives.
Community Development Block Grant. A highly controversial provision in the bill would provide $4 billion in community development block grants for the purchase and rehabilitation of foreclosed homes. These federal grants will be given to state and local governments, allocated based on a funding formula devised by HUD. Need would be demonstrated based on the number and percentage of:
- home foreclosures in the state;
- homes financed by a subprime mortgage related loans in the state; and
- homes in default or delinquency in each State or locality.
In part, the legislation allows for a discounted sales price from the property’s market value based on its current condition. Moreover, any required rehabilitation of the property must place the property in compliance with housing laws and codes in order to resell, rent or redevelop the property. Once rehabilitated, if the property is later sold as a primary residence, it will be sold at an amount equal to or less than the cost to acquire and rehabilitate the property.