(This is the third in a series of Legal Alerts from Arent Fox LLP that examines the new Housing and Economic Recovery Act of 2008 signed into law by President George W. Bush on July 30, 2008)

On July 30, 2008, President Bush signed the Housing and Economic Recovery Act of 2008 into law.  As the Act relates to the government-sponsored enterprises (the GSEs), Fannie Mae and Freddie Mac, it is designed to accomplish two goals. One goal is to provide assurance to the marketplace that, if necessary, the federal government has the authority to provide financial support to the GSEs. The second goal is to provide stricter oversight and regulation of Fannie Mae and Freddie Mac, primarily monitoring their use of sound financial practices and encouraging the GSEs to continue to serve the public good.   

The Act gives explicit authority to the federal government to provide financial support to the GSEs. This support was assumed by many market participants, but until the passage of this Act, it was not explicitly authorized by federal law. The US secretary of the treasury can infuse money into the GSEs by utilizing its authority to buy obligations and securities of Fannie Mae and Freddie Mac. Any such purchase must be agreed upon by the GSEs. The treasury secretary may use this authority upon determining that the purchase is necessary to “(i) provide stability to the financial markets, (ii) prevent disruptions in the availability of mortgage finance, and (iii) protect the taxpayer.” This authority is broad and intended to provide comfort to the marketplace even though it may never be exercised. The authority expires on December 31, 2009.

The price the Act imposes for the potential of such financial support is unprecedented regulatory oversight. Previously, the Department of Housing and Urban Development and the Office of Federal Housing Enterprise Oversight have the authority to regulate the GSEs. The Act creates the Federal Housing Finance Agency, an independent agency of the federal government, which will have significantly greater regulatory authority over the GSEs. The Federal Housing Finance Agency will be headed by a director, appointed by the president of the United States and confirmed by the Senate, who will have strong decision-making authority. The Federal Housing Finance Agency board will comprise the secretary of housing and urban development, secretary of the treasury, the chairman of the Securities and Exchange Commission and the director.

The director will establish rules for Fannie Mae and Freddie Mac, which may encompass self-regulation, internal audit systems, management of risk, and adequacy of liquidity and reserves. The director has complete discretion to determine whether the GSEs are complying with the regulations that have been promulgated and to carry out the prescribed remedies and penalties. The director also has a more open-ended right to increase the minimum capital level and to require a temporary increase in the minimum capital level for Fannie Mae and Freddie Mac above the levels required under law, if either increase is necessary for the soundness of their operations. 

Another example of the increased regulation of the GSEs is the increased discretion over the approval of new products created by Fannie Mae and Freddie Mac. Previously, a “new program” would be approved by the HUD secretary, unless it was not authorized under the GSE’s charter acts or was not in the public interest. This Act changes the standard for approval and requires the director to consider the effect of the product on the operations of Fannie Mae or Freddie Mac, as the case may be, and the entire business of mortgage finance, prior to approving any products. Even if a product is approved, the director can place restrictions on the offering of the product.  The GSEs must also give the director prior written notice of any new activities. The director may determine that the new activity should be considered a product and subject to the more stringent evaluation and review. 

The Act also strengthens and increases the external supervision and restrictions on the actions of Fannie Mae and Freddie Mac in the event that either entity is deemed to be undercapitalized or significantly undercapitalized. The Federal Housing Finance Agency is required to monitor the condition of the undercapitalized entity and to review any capital restoration plan. If deemed undercapitalized, the GSEs would only be permitted to engage in new activities or allow for asset growth under very limited circumstances, which are subject to the decision-making of the agency director. If either company is found to be significantly undercapitalized, the agency may order the replacement of the board of directors. 

There are additional consequences if the agency director determines that either GSE is critically undercapitalized. The director may also appoint the agency as a conservator or a receiver, if any one of a number of conditions exists, for example, in the event Fannie Mae or Freddie Mac does not have enough assets to cover their obligations or either company is in an “unsafe and unsound condition”. The director has a mandatory obligation to appoint a receiver if the director determines that (i) the current assets and the assets over the prior 60 days are less than the obligations due to creditors and others, or (ii) during the preceding 60 days, Fannie Mae or Freddie Mac have not been paying their debts as they become due. 

The powers of the agency as a receiver or conservator are broad. If the agency becomes the receiver or conservator over Fannie Mae or Freddie Mac, the agency is not subject to any controls by any state or agency of the federal government and the agency will step into the shoes of the failing entity and carry out all of its operations. If a GSE is in receivership, the agency, in its function as receiver, is required to place the entity in liquidation.

The director shall have the right to enforce the provisions of the Act and assess penalties against the offending parties. Some of the enforcement rights of the director are: (i) removal or suspension of an officer or director of Fannie Mae or Freddie Mac for specified violations, (ii) imposition of monetary penalties in amounts greater than those currently in effect, and (iii) sanctioning of criminal penalties for individuals who have been removed or suspended, and continue to participate in the business of the company.  

In addition to the new regulations, Fannie Mae and Freddie Mac are being charged to lead the secondary mortgage market for low income and underserved populations. Starting in 2010, the agency is authorized to establish goals for the purchase of mortgage loans for certain types of properties. The Federal Housing Finance Agency will utilize a set of criteria, which differs from those currently in effect, to establish housing goals that encourage the GSEs to purchase greater numbers of mortgage loans provided to low income individuals or where the mortgaged property is in a low income area. The agency will also establish goals for the purchase of mortgage loans on multifamily properties where the mortgage loan finances affordable housing for low income individuals. The Act gives Fannie Mae and Freddie Mac the responsibility to initiate new loan products and create flexible underwriting to boost the secondary loan market for low and moderate income families with respect to manufactured housing, federally subsided housing, such as Section 8 housing, and housing in rural areas. 

If you have any questions or comments on this Legal Alert, please do not hesitate to contact the Arent Fox attorneys listed.