The long-awaited notice of proposed rulemaking on PACE (property assessed clean energy) financing by Fannie Mae and Freddie Mac was released by the Federal Housing Finance Agency (FHFA) on June 15. The results are disappointing and consistent with FHFA’s narrow view of its responsibilities at the helm of secondary mortgage financing giants Fannie Mae and Freddie Mac.
As regulator, FHFA is charged with ensuring that Freddie and Fannie operate in a “safe and sound manner.” As conservator, the agency is charged with putting each “regulated entity into safe and solvent condition.” And FHFA and its director, Ed DeMarco, have certainly done some good. Fannie Mae’s first quarter 2012 results showed a $2.7 billion profit, its first reported net gain since it was put into conservatorship in 2008.
At the same time, FHFA is widely considered a roadblock to much-needed mortgage industry reforms that would stabilize the housing sector and bolster U.S. economic growth. The agency’s refusal to consider principal writedowns for underwater home mortgages held by Fannie and Freddie—an approach that FHFA’s own data has suggested is cost-effective -- has drawn the ire of many, including HUD Secretary Shaun Donovan, the attorney general of California, and Democratic members of Congress.
FHFA appears to be taking a similar path with respect to PACE. As I wrote last fall, PACE is a potentially valuable financing mechanism to create U.S. jobs and to advance energy efficiency in residential and commercial buildings. But FHFA’s 2010 refusal to let Fannie and Freddie participate in PACE programs shuttered most residential PACE efforts and cast a cloud over the growing PACE industry.
In PACE programs, local governments front the cost of energy efficiency improvements like solar panel installation and then levy special taxes on homeowners who choose to participate. The governments secure their investment by placing a lien against participating properties, and it's those liens the FHFA objects to. The agency says because those liens are first in line, ahead of mortgages on the property, they raise safety and soundness concerns for mortgage lenders.
Next page: FHFA supports a ban on PACE
The June 2012 notice says FHFA favors a continued ban on Freddie’s and Fannie’s participation in PACE programs. Admittedly, the notice presents for public comment by July 30 three risk mitigation alternatives that might induce FHFA to permit Fannie and Freddie to buy PACE-encumbered debt, including:
- Alternative 1: Irrevocable insurance guarantees for 100% of potential PACE losses and program loss reserves satisfactory to FHFA.
- Alternative 2: Strict limitations on loan and borrower characteristics, including loan size (the lower of $25,000 or 10% of property value) and borrower credit scores (a minimum of 720)
- Alternative 3: Underwriting standards suggested in H.R. 2599, pending Congressional legislation that would require Fannie Mae and Freddie Mac to participate in residential PACE programs.
Unfortunately, FHFA declares in the notice that it is interested only in public comments “supported by reliable data and rigorous analysis showing that any of these alternatives … would provide mortgage holders with equivalent protection from financial risk … and could be implemented as readily and enforced as reliably” as the proposed ban. That’s an insupportable and unfair hurdle for an emerging industry in which data is only beginning to emerge.
To add insult to injury, FHFA’s treatment of comments received is hardly even-handed. Comments critical of PACE, while comparatively few, are given equal or greater weight than favorable comments. By its own account, FHFA received an estimated 33,000 form letters supporting PACE, as well as 400 substantive comments, of which “[m]ost but not all expressed support for PACE programs,” while “[s]ome expressed limited or qualified support for PACE programs, and a few expressed opposition to or reservations about first-lien PACE programs.”
Moreover, FHFA appears to have highlighted comments about difficulties associated with PACE implementation, without benefit of context. FHFA did just that with the excerpt that it chose to publish from the comments that I submitted with colleagues. FHFA quoted our statement that recent housing price volatility demands additional research to test whether energy retrofits increase home values, implying that this undermines the feasibility of PACE. In fact, our comments to FHA strongly support PACE research and financing, as well as Fannie’s and Freddie’s participation in PACE, at least on a pilot basis. [Note: the opinions expressed in this blog do not necessarily reflect the views of my comment letter co-authors.]
Similarly, the American Land Title Association’s reservations about some of the features of current PACE programs are quoted by FHFA, while ALTA’s support of FHFA development of rules for PACE participation is not.
Most disturbingly, comments opposing FHFA’s participation in PACE are not held to the same evidentiary requirements as pro-PACE comments. While quantitative evidence supporting PACE programs is indeed limited, I could find no compelling quantitative evidence in FHFA’s notice to suggest that PACE program participation would present significant, systemic risks to Freddie Mac and Fannie Mae, especially if sensible national rules are promulgated by FHFA.
FHFA’s wariness of PACE is even more striking in that it dismisses the foundational benefits of other underwriting approaches to PACE, including proposals from the White House and the federal Council on Environmental Quality, the U.S. Department of Energy, and Congressional sponsors of H.R. 2599, bipartisan legislation to require that Fannie and Freddie participate in PACE. States the notice: “FHFA believes that… the[se] underwriting standards are complex, incomplete and impractical….” Relevant building energy retrofit standards developed by industry groups are ignored completely.
Might FHFA itself be part of a PACE solution by developing appropriate national underwriting standards in consultation with building energy retrofit experts? Many comment letters suggest this as the notice admits, but FHFA concludes that this role is “outside the field of FHFA’s expertise.”
Clearly, proactive approaches remain in short supply at FHFA on building energy retrofit issues. It’s a shame, because FHFA and Ed DeMarco could do much better.