Shhh! Don’t tell anybody about the 4.2 basis points
On July 30, 2008, the President signed into law the Housing and Economic Recovery Act of 2008 (“The Act”). The Act is segmented into three smaller acts, two of which have been highly publicized by the press; these are the Federal Housing Finance Regulatory Reform Act of 2008 and the Foreclosure Prevention Act of 2008.
To summarize, the following provisions have received a lot of press attention:
1. Establishment of the Federal Housing Finance Agency to replace the Office of Housing Enterprise Oversight (OFHEO) and the Federal Housing Finance Board (FHFB), expanding government oversight over the GSEs.
2. An increase in conforming loan limits (loans eligible for purchase by Fannie Mae and Freddie Mac) in areas where median home prices are greater than pre-existing conforming loan limits. This will give lenders more capital by allowing them to sell illiquid, jumbo loans to Fannie Mae and Freddie Mac, who in turn will resell them into the secondary market – creating a liquid secondary market for jumbo mortgages.
3. Establishment of the GSE Credit Facility (GSECF), whereby the Treasury will extend short-term loans to the GSEs at L+50 in exchange for MBS collateral.
4. Establishment of HOPE for Homeowners, a program that allows borrowers to refinance out of high-LTV, predatory loans into lower-principal, FHA-insured, 30-year fixed-rate mortgages.
This commentary will discuss legislation in the Housing and Economic Recovery Act not related to the current economic state of affairs. Specifically, the legislation does not cleanly seek to restore the housing market but contains extraneous provisions that result from having a Democrat-controlled Senate and House of Representatives. The most egregious of these is the 4.2 basis points tax on Fannie Mae and Freddie Mac that will be allocated to a new “Affordable Housing Trust Fund.”
Section 1338 of the Housing and Economic Recovery Act establishes an “Affordable Housing Trust Fund” to construct affordable rental housing for “extremely” low-income households. Specifically, the bill language states the purpose as follows:
A. To increase and preserve the supply of rental housing for extremely low and very low-income families, including homeless families.
B. To increase homeownership for extremely low and very low-income families.
Allocation of Moneys into the Fund
The Act establishes a formula to determine the amounts to be allocated to the fund. The formula changes on a yearly basis until FY2012 and remains constant each year thereafter.
Starting in 2009, Freddie Mac and Fannie Mae will be required to set aside 4.2 basis points of each dollar of new loans purchased during each fiscal year. Twenty-five percent will be transferred to the Treasury to offset lower tax payments as a result of the GSEs’ lower taxable income.
In FY09, the remaining 75% of moneys will be allocated to the aforementioned FHA insurance program, HOPE for Homeowners.
In FY10, 50% of the remaining moneys (after Treasury’s 25% tax reimbursement) will be applied to HOPE for Homeowners, while 32.5% of the balance will be applied to the Housing Trust Fund and 17.5% will be applied to the Magnet Capital Fund. The Magnet Capital Fund will provide capital on a contracting basis to private enterprise to help “develop, preserve and rehabilitate” low-income housing.
In FY11, 25% of the remaining moneys will be allocated toward HOPE for Homeowners. Of the remaining 75%, 48.75% will be allocated to the Housing Trust Fund and 26.25% will be allocated to the Magnet Capital Fund.
In FY12 and beyond, 100% of all moneys received will be allocated to the Housing Trust Fund and Magnet Capital Fund, 65% and 35% to each, respectively.
The amount to be allocated to the Housing Trust Fund, assuming no diversions to the HOPE Program Fund in 2007, would have been $557 million, based on $1.32 trillion of new mortgages acquired by Fannie Mae and Freddie Mac.
Where’s the Money Going?
Moneys deposited into the funds are to be allocated to states to construct rental housing, based on a formula to be determined by the secretary of the Department of Housing and Urban Development, within 12 months of passage of the Act. The act gives the general formula for each state as follows:
The summation of the ratios listed below x (average construction costs for the state / average national construction costs)
1. Shortage of standard rental units affordable and available to extremely low-income renter households in a state divided by the shortage of standard rental units affordable and available to extremely low-income renter households in the United States.
2. Shortage of standard rental units affordable and available to very low-income renter households in a state divided by the shortage of standard rental units affordable and available to very low-income renter households in the United States.
3. The ratio of extremely low-income renter households in the state living with either (I) incomplete kitchen or plumbing facilities, (II) more than 1 person per room, (III) paying more than 50% of income for housing costs, to the aggregate number of extremely low-income renter housings living with either, (I), (II), or (III) in the United States.
4. The ratio of very low-income renter households in the state living with either (I) incomplete kitchen or plumbing facilities, (II) more than 1 person per room, or (III) paying more than 50% of income for housing costs, to the aggregate number of very low-income renter housings living with either, (I), (II), or (III) in the United States.
*Note, priority is to be given to #1 in this list of ratios.
Whether or not the US needs another affordable housing program of this magnitude is a matter of debate. Consider the following:
1. The legislation was first proposed on October 10, 2007, in a macroeconomic environment much different from that of July 30, 2008 when it was passed.
a. For starters, Fannie and Freddie’s combined market capitalization was $106 billion at that point in time. It was $20 billion on the date of the bill’s passage. It is currently $2.1 billion.
b. The fund seeks to extract $9 billion from Fannie and Freddie over a ten-year period. This comes after a $2 billion preferred stock sale to the federal government, with options to purchase up to 79.9% of outstanding common shares – effective nationalization of the two companies.
c. The 4.2 basis point tax on new business purchases undermines the intent of the original legislation by increasing borrowing costs. Both companies are insolvent and will be forced to pass on the tax to lenders in the form of higher guaranty fees on mortgages, which in turn will be passed on to borrowers seeking to buy homes.
All things considered, the legislation contains much-needed provisions that seek to strengthen oversight of the GSEs, such as giving the director of the FHFA the ability to set capital requirements and restrict portfolio asset growth. It also attempts to put an end to processes in the mortgage origination process that started the sub-prime mortgage crisis.
Unfortunately, the legislation contains costly programs unrelated to issues at hand as well, such as the National Affordable Housing Trust Fund.