Mortgage guarantees and PACE assessments
The Property Assessed Clean Energy (PACE) program would allow municipal governments to finance the up-front costs of home improvements designed to reduce energy and water consumption and provide clean power. Under the PACE program, municipalities issue a bond and lend money to homeowners for energy conservation and environmental projects on the property. The homeowner would pay back the loan through tax assessments, typically over a 15-year or a 20-year period. The tax lien is attached to the property, not to the person who took out the loan. A new owner continues to pay the tax lien once the property is sold. In the case of a mortgage default, the tax lien on the property used to pay for the home improvement would take priority over the mortgage payments due the lender and guaranteed by Freddie Mac or Fannie Mae.
The Federal Housing Finance Agency (FHFA) prohibited Fannie Mae and Freddie Mac from acquiring mortgages on homes that participated in the PACE program. In 2011, a U.S. District Judge ordered FHFA to adopt rules codifying its action. The ninth circuit court of appeals has ruled that FHFA need not adopt formal rules when it acts as a conservator of the two agencies.
This post provides my thoughts on PACE and the FHFA decision.
Comment One: Financial risks imposed by the PACE program on Fannie Mae and Freddie Mac appear small compared to the myriad of problems ignored by FHFA prior to the housing market meltdown that led to the bankruptcy of the two housing agencies.
Comment Two: The concern that PACE assessments will lead to higher foreclosure losses is valid but not unique. There already exists a wide dispersion of tax assessments across states and communities because of dispersion in the general level of taxation and in the reliance on real estate taxes. Neither Fannie Mae nor Freddie Mac restrict guarantees on mortgages in jurisdictions with high real estate tax assessments even though tax assessments always take priority over mortgage payments. It would be useful to understand why the FHFA treats tax assessments for energy projects differently than tax assessments for other spending projects.
Comment Three: It seems as though a PACE assessment on a home that does not have a current mortgage guaranteed by Freddie Mac or Fannie Mae would not impose any risk on the two agencies. The agencies would simply have to avoid buying a loan on any property with a PACE assessment.
It also seems as though homes with PACE assessments should still be able to obtain financing through the jumbo market or other government guarantee programs. Moreover, PACE projects on larger homes financed with jumbo loans should result in greater energy savings. Even though Freddie Mac and Fannie Mae are the big players in this industry the other sectors are not insignificant.
Comment Four: A recent paper found that mortgages on homes that have adopted fuel-savings projects have a lower default rate than mortgages on other homes.
The primary determinant of whether a homeowner defaults on his or her mortgage is whether household equity is negative. However, most homeowners with negative equity actually do not default on their home and lower energy costs reduces the likelihood of defaulting because the owner will experience an increase in costs at the new home.
The lower default rate for homeowners with energy savings improvements on their homes would decrease losses to Freddie Mae and Fannie Mac; thereby, offsetting some losses from the priority of the PACE assessment.
Comment Five: FHFA does not oppose energy loans as long as the mortgage has priority in foreclosure. However, the cost of the energy loan might be higher than PACE financing and payment problems from the new loan could increase defaults relative to the number of defaults that would have ocurred under a PACE program.
Moreover, households who anticipate moving are often reluctant to take out a loan with a longer duration than their expected time in the home. This reluctance is quite practical given uncertainty about the future value of the home.
Concluding thoughts: I understand the FHFA is troubled over the priority that PACE assessments have over mortgage debt but I believe their reaction is disproportionate to the potential harm. Where was this regulatory energy during the housing bubble?
The FHFA decision to prohibit the PACE program is arbitrary. Many states and communities have extremely high real estate assessments and mortgage payments are always secondary to tax liens. The FHFA does not have general restrictions on loan guarantees in high real estate tax assessment jurisdictions. Why has the PACE program been singled out?
Here are some other concerns and questions:
Taxes are not the only source of risk to Freddie Mac and Fannie Mae. A much larger source of risk is second mortgages and piggy back liens. Often second mortgage holders demand and receive a payment from the first mortgage holder in order to restructure loans in foreclosure. Could FHFA prohibit Freddie Mac and Fannie Mae from issuing piggy back loans. Now that FHFA is the conservator could this change be done without a formal order?
Does the FHFA restriction on Freddie Mae and Fannie Mac create a profit making opportunity for a private firm willing to guarantee mortgages on homes with PACE assessments?
Would the restriction on PACE lending result in some support for a GSE reform or privatization proposal that would allow for a private entity to guarantee mortgages with PACE assessments?
Why did the FHFA decide to prohibit Freddie Mac and Fannie Mae from guaranteeing all PACE loans? Wouldn’t a risk-based guarantee price achieved a similar effect?
Here is some reading material on PACE. Enjoy!!!!!