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Legislative Updates

January 11, 2008

I. Policy Outlook for 2008

The November elections will govern legislative action in 2008. The elections will both shorten the timeframe in which legislation can be reasonably expected to be enacted (late July is probably the endpoint for consideration of significant legislation) and will create additional tension (if that is possible) between the two political parties.

A. Subprime Mortgage Crisis: All financial policy debates in 2008 will be dwarfed by the subprime mortgage crisis and the looming harm it may spawn. Foreclosures, losses by public investment funds, depressed housing markets, and the overall credit crunch are but some of the reasons there will be so much pressure to act.

Congress and the Administration will be grappling with three major policy objectives:

• To reform the origination of subprime loans and the regulation of mortgage brokers going forward;
• To ensure that securities markets do not exacerbate problems in the future; and
• To develop the appropriate response for the estimated 2 million loans that will likely be in foreclosure when teaser ARMs adjust for overstretched borrowers.

For an overview of all legislative and administrative actions taken in the last month and a half to address this crisis, please refer to Attachment 1.

B. Government-Sponsored Enterprise (GSE) Reform: The four-year effort to create a new regulator of Fannie Mae, Freddie Mac, and the Federal Home Loan Banks continues. The House of Representatives passed GSE reform by a very respectable margin of 313-104 on May 22, 2007. The main points of contention were the creation of an affordable housing fund (AHF) for Fannie Mae and Freddie Mac similar to the FHLBank Affordable Housing Program (AHP) and the ability of the new GSE regulator to control portfolio growth at Fannie Mae and Freddie Mac.

House consideration occurred before the subprime crisis came to dominate policymakers’ attention. At that time, the Administration expressed strong concern over the new regulator’s power to control the portfolios of Fannie Mae and Freddie Mac and also opposed increasing their mortgage purchase limits. The Treasury is now working for passage of the House bill and supports a temporary increase of conforming loan limits for securitization.

This legislation will continue to receive consideration. The overriding concerns about the mortgage markets will lead Congress to turn over every stone in search of a solution and GSE reform is now mentioned as part of the response to the crisis.

C. Legislation to Amend Section 149(b) of the Internal Revenue Code: Tax legislation introduced in the House by Ways and Means Committee members Levin (D-MI) and English (R-PA), H.R. 2091, and in the Senate by Finance Committee members Rockefeller (D-WV) and Crapo (R-ID), S. 1963 would allow FHLBanks to support member banks’ letters of credit for tax-exempt bonds.

Tax legislation in a presidential election year is rare, but cosponsorship levels in both bodies are rising (41 in the House at year-end 2007 and 10 in the Senate), and the list of supporting groups is similarly growing. The bond insurers’ weakness and their inability to serve tax-exempt bond markets may present opportunities for FHLBanks tax legislation. If this legislation is not enacted in 2008, it will be re-introduced in 2009 and the effort will continue.

D. Federal Housing Finance Board Regulatory Actions: The Finance Board still plans to develop new risk-based capital rules for FHLBanks that would include a component for retained earnings. No timeframe for this action has been given.

E. Agriculture Bill: The House and Senate have passed re-authorizations of federal agriculture programs without endorsing the Farm Credit System (FCS) “Horizons Project” that would have allowed the FCS to make mortgage loans in communities up to 50,000 (up from the current 2,500) and allow a broad expansion of direct commercial lending to anyone who supports farmers or ranchers. This language would have allowed almost unfettered commercial lending in rural communities.

Since this legislation is in conference, the Horizons Project could re-emerge. The Banking trades are continuing to oppose the Horizons Project very aggressively.

II. Treasury Secretary Recognizes FHLBank Advances

On January 7, during a speech on the economy, Treasury Secretary Paulson noted the liquidity provided by FHLBanks. The Secretary said, “Another housing-related GSE, the Federal Home Loan Bank (FHLB) System, has provided a considerable amount of liquidity to financial institutions. In the third quarter alone, the 12 Federal Home Loan Banks provided an additional $184 billion to borrowers within the system, funding that enables banks and thrifts to continue to lend.”

III. Federal Housing Finance Board (FHFB) Director Mendelowitz Confirmed

On December 19, 2007, Senate voted unanimously to confirm Allan Mendelowitz to another term as Director of the Federal Housing Finance Board. This term expires on February 27, 2014.

Attachment 1

An Overview of Legislative and Administrative Actions to Respond
to the Subprime Mortgage Crisis

I. Legislative Actions

A. Mortgage Relief Tax Bill Signed into Law

On December 20, 2007, President Bush signed into law a mortgage relief tax bill, which will provide a three-year exclusion from income of debt forgiven when a mortgage is foreclosed or renegotiated. The measure also offers a three-year extension of the private mortgage insurance deduction.

B. House Passes Mortgage Reform and Anti-Predatory Act

On November 15, 2007, by a vote of 291-127, the House passed the Mortgage Reform and Anti-Predatory Lending Act that would: ·1 Set standards for originating and securitizing subprime mortgages; ·2 Expand the definition of high-cost loans under the Home Ownership and Equity Protection Act of 1994 (HOEPA) to include first-lien mortgages more than 8 percentage points over a benchmark Treasury security, second-lien mortgages over 10 percentage points, and mortgages including total points and fees of more than 5 percent of the loan amount; ·3 Place new restrictions on these "high-cost" mortgages; ·4 Expand legal options for borrowers; ·5 Impose new rules for appraisers; ·6 Preempt states from imposing tougher rules in regard to standards set for the secondary market, but would leave room for states to set a higher bar for consumer protections in regard to loan originators; and ·7 Impose assignee liability at the securitizer, who bundles mortgages and sells mortgage-backed securities, while offering investors a "safe harbor" if they purchase mortgages that meet certain standards of quality.

C. Chairman Dodd Introduces Predatory Lending Legislation

On December 12, 2007, Senate Banking Committee Chairman Christopher Dodd (D-CT) introduced legislation stronger than the House-passed legislation. As introduced, the bill includes:

• A complete ban on prepayment penalties, yield spread premiums and debt-to-income ratios above 45 percent for subprime and nontraditional mortgages;
• An expansion of the definition of "high-cost" loans;
• Suitability standards;
• Delays to the foreclosure process;
• No federal preemption of state law; and
• No assignee liability safe harbor for investors.

It is generally known that Chairman Dodd has introduced this legislation as a starting point and that any legislation that might be reported out of the Senate Banking Committee and later passes the Senate may be dramatically different.

D. Bankruptcy Reform Under Consideration

On December 12, 2007, the House Judiciary Committee approved a bill that would let bankruptcy judges modify subprime and nontraditional mortgages made from January 1, 2000, through the bill's enactment date with a sunset in seven years. Senate Majority Whip Richard Durbin (D-IL) is pursuing his own somewhat broader bill and trying to reach a deal with Sen. Arlen Specter (R-PA), the Senate Judiciary Committee's lead Republican.

E. FHA Mortgage Reform Bills Pass House and Senate

The House (349-72) and Senate (93-1) both passed FHA Reform legislation in 2007. The bills are now in a House-Senate conference which must iron out differences before the bill goes to the President for signature.

Both bills increase the maximum mortgage that can be insured by the FHA. The Senate bill raises the maximum high-cost areas from $362,790 to $417,000 (the same as the conforming loan limit for Fannie Mae and Freddie Mac) while the House bill increases the amount to $729,750 in high-cost areas.

The Senate bill lowers the current 3 percent FHA down payment requirement to 1.5 percent, while the House allows mortgages with no down payment requirement.

Low-priced areas in both bills would be raised to $271,050 from $200,160.

The House bill extends the maximum term of the mortgage to 40 years from 35, while the Senate bill makes no such change.

F. Administration Backs Expansion of Tax-Exempt Mortgage Bonds

Under current law, state and local housing agencies are allowed to issue tax-free bonds only to help subsidize the cost of mortgages for first-time home buyers or home buyers purchasing property in distressed areas. The Administration is proposing that the law be amended to allow refinancing for subprime borrowers.

In addition, Treasury officials have supported increasing the dollar cap on the amount of tax-free bonds issued by states and localities by $15 billion over three years.

II. Regulatory Action - The Fed’s Proposed Mortgage Lender Regulation

On December 18, 2007, the Federal Reserve Board issued for comment a proposed rule that would increase regulation of mortgage lenders, including those currently unregulated. The amendment to Regulation Z (Truth in Lending), which implements HOEPA addresses a wide range of abuses.

"Higher-priced" loans must be underwritten on the basis of the borrower's ability to repay, rather than a residential property's collateral value. Higher-priced loans are defined as any first-lien mortgage with an interest rate of 3 percentage points over a Treasury security of comparable maturity which is identical to the definition for higher-priced mortgages under the Home Mortgage Disclosure Act (HMDA). The threshold for second liens would be 5 percentage points.

Lenders that exhibit a "pattern or practice" that violates such standards could be subject to civil liability under the proposal.

Lenders must take reasonable measures to verify borrowers' income and assets and require establishment of escrows to assure tax and insurance costs are folded into consumers' monthly payments.

Prepayment penalties are limited but not prohibited under all circumstances.
Lenders’ payments to mortgage brokers are limited, unless the borrower receives appropriate and timely disclosures.

Yield spread premiums are prohibited unless the broker signs a written agreement with the borrower that discloses the total dollar amount of the compensation due to the broker.

Senate Banking Committee Chairman Christopher Dodd (D-CT) and House Financial Services Committee Chairman Barney Frank (D-MA) both criticized the rule in very strong terms as not going far enough.

III. Government-Private Sector Initiative - The Hope Now Program

Excerpts from Treasury and White House material describing the Hope Now Program for subprime mortgage relief:

The Hope Now Alliance consists of four counseling organizations, 21 mortgage servicers and lenders (comprising 65 percent of the U.S. market for mortgage servicing and almost 85 percent of the subprime servicing market), three investor groups (including the American Securitization Forum, which represents over 370 members), and 10 trade associations. This is a private sector effort, involving no government money.

Hope Now members have agreed on a set of new industry-wide standards to provide systematic relief to these borrowers in one of three ways: refinancing an existing loan into a new private mortgage; moving them into an FHA loan; or freezing their current interest rates for five years.

The current system for working out problem loans would not be sufficient to handle the anticipated 1.8 million owner-occupied subprime mortgage resets that will occur in 2008 and 2009. Fifty percent of foreclosures occur without borrowers ever talking to their lender or a mortgage counselor. In the past, some servicers may not have contacted borrowers until after their loans were delinquent. Today, all Hope Now servicers are contacting borrowers 120 days in advance of their mortgage reset, to reach them early, before their mortgage problems become overwhelming.

The standard loan-by-loan evaluation process that is current industry practice would not be able to handle the volume of work that will be required. To deal with this, the Hope Now alliance is developing:
New industry guidelines, to be issued by the American Securitization Forum, to create an efficient process for identifying borrowers who qualify for a loan modification or refinancing. Under this new agreement, the servicers estimate that up to 1.2 million subprime, adjustable rate mortgage holders may be eligible for a fast-track refinance or loan modification.

Standard measures which will identify categories of borrowers who can be helped, determine successful treatments, and measure the rate of successful outcomes.
Developing an approach based on four levels of sub-prime borrowers:

1. Those who can afford their adjusted interest rate, these homeowners need no assistance.

2. Homeowners who haven't been making payments at the starter rate on their sub-prime loan, and may not have the wherewithal to sustain homeownership. These homeowners will likely become renters again.

3. Homeowners who might choose to refinance their mortgage, putting them in a sustainable mortgage while keeping investors whole. This is the first, best option. Servicers should move quickly to assist those who can refinance.

4. Those with steady incomes, and relatively clean payment histories who could afford the lower, introductory mortgage rate, but cannot afford the higher, adjusted rate. We are focusing on this group, determining who they are and what steps may be appropriately taken to assist them.