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Daniel A. Piper

Daniel A. Piper Real Estate

dpiper@fredlaw.com
612.492.7294
Printable Version
Mary S. Ranum

Mary S. Ranum Real Estate

mranum@fredlaw.com
612.492.7072
Printable Version

The Emergency Economic Stabilization Act: A Real Estate Perspective

For additional resources on the Emergency Economic Stabilization Act, click here.

By: DANIEL A. PIPER & MARY S. RANUM

October 27, 2008

By now you have almost certainly heard about the new Emergency Economic Stabilization Act (EESA) of 2008, passed by Congress and signed into law by President Bush on October 3, 2008. In all likelihood, you have also heard that the purpose of EESA was to stabilize the economy and restore liquidity to the “frozen” credit markets. If you are like most people, however, you continue to have questions about what exactly EESA does and how it will work. This article attempts to answer some of those questions, with a particular emphasis on the consequences for the real estate industry. Because most of the attention dedicated to EESA has focused on the consequences for financial institutions, this article will begin by focusing on some of the lesser known provisions included in EESA that relate directly to the real estate industry. The discussion will then shift to the provisions related to real estate lenders.

I.  What Real Estate-Related Provisions Were Included in EESA?


EESA included amendments to the HOPE for Homeowners Act (HOPE), which was passed on July 30, 2008. As originally enacted, HOPE allowed eligible borrowers who had a mortgage debt-to-income ratio of at least 31% to get a new FHA mortgage with a 30-year term at a fixed rate, for an amount equal to no more than 90% of the appraised value of the home. In addition, before the new mortgage could be obtained, all subordinate lenders had to agree to have their liens extinguished in exchange for an agreement to share any future appreciation of the home with the FHA. The sticking point for the HOPE program was that it was voluntary for lenders, and HOPE has often been criticized because there is little incentive for lenders to agree to participate. The amendments contained in EESA were apparently designed to address this problem. Now, the FHA has the discretion to write down the loan to an amount greater than 90% of the appraised value of the home. The amendments also allow the FHA to make a one-time payment to subordinate lienholders in lieu of entering into an agreement with such lienholders to share in future appreciation of the mortgaged property. Additionally, the amendments allow more borrowers to qualify for the HOPE program, including those “likely to have, due to the terms of the mortgage being reset” a mortgage debt-to-income ratio greater than 31%. In spite of these amendments to HOPE, however, the principle criticism remains: the program is still voluntary. Congress is currently considering other alternatives to the HOPE program that may be mandatory.

EESA includes other provisions that attempt to increase the use of the HOPE program. In particular, to the extent that the Treasury purchases any mortgages, mortgage backed securities, and other assets secured by residential real estate (pursuant to the programs discussed in Section II below), the Treasury must implement a plan that seeks to maximize assistance for homeowners and encourages the servicers of the underlying mortgages, “considering net present value to the taxpayer,” to take advantage of the HOPE for Homeowners Program or other available programs to minimize foreclosures.

EESA also allows the Treasury to use “loan guarantees and credit enhancements to facilitate loan modifications to prevent avoidable foreclosures.” EESA does not make clear exactly how such guarantees and enhancements will be used.

EESA requires the Treasury to “consent, where appropriate, and considering net present value to the taxpayer, to reasonable requests for loss mitigation measures, including term extensions, rate reductions, [and] principal writedowns.” Of course, this provision depends upon the Treasury having control over the mortgages for which loss mitigation measures are requested.

EESA also extended a provision of the Internal Revenue Code that allows taxpayers to exclude from taxaction certain discharges of indebtedness from income, if the discharges relate to declines in the value of the home or the homeowner’s financial condition.

II.  How Does EESA Impact Real Estate Lenders?


EESA authorizes the Treasury to spend up to $700 billion on the Troubled Asset Relief Program (TARP). The Treasury may purchase or guarantee “troubled assets” under TARP. Additionally, as part of TARP, the Treasury has announced a capital purchase program.

         A.  The Treasury Has Initiated a Capital Purchase Program.

The TARP capital purchase program was announced on October 14, 2008. Under the program, qualifying financial institutions (the Treasury will determine eligibility, apparently on a case-by-case basis) may agree to sell senior preferred shares to the Treasury. Nine large financial institutions agreed to participate in the program on the day it was announced, and the same terms are being offered to small and medium-sized banks and thrifts.

The senior preferred shares will pay dividends at a rate of 5% per annum for five years, and at a rate of 9% thereafter. The senior preferred shares will be non-voting.

In conjunction with the sale of the senior preferred shares to the Treasury, the Treasury will also receive warrants to purchase common stock with an aggregate market price of 15% of the senior preferred investment. The exercise price on the warrants will be the market price of the financial institution’s common stock at the time of issuance.

Financial institutions that participate in the capital purchase program must adopt the Treasury’s standards for executive compensation for senior executives (i.e., the five executives with the highest pay at the financial institution). These standards include: (1) ensuring that incentive compensation for senior executives does not encourage unnecessary and excessive risks that threaten the value of the financial institution; (2) required clawback of any bonus or incentive compensation paid to a senior executive based on statements of earnings, gains or other criteria that are later proven to be materially inaccurate; (3) prohibition on the financial institution from making any golden parachute payment to a senior executive; and (4) agreement not to deduct for tax purposes executive compensation in excess of $500,000 for each senior executive.

Financial institutions must elect to participate in the capital purchase program no later than November 14, 2008. Financial institutions that wish to participate should contact their primary federal regulator (the Federal Reserve, the FDIC, the OCC or the OTS) for enrollment details. Applications to participate in the program are available at: http://www.ustreas.gov/press/releases/reports/applicationguidelines.pdf.

         B.  EESA Authorizes the Treasury to Purchase Troubled Assets.

               1.  Whose Troubled Assets Can Be Purchased Under TARP?

EESA authorizes the Treasury to purchase “troubled assets” from any financial institution, which includes “any bank, savings association, credit union, security broker or dealer, or insurance company, established and regulated under the laws of the United States or any State, . . . and having significant operations in the United States.”

               2.  What Are the “Troubled Assets” That Can Be Purchased?

“Troubled assets” include “residential or commercial mortgages and any securities, obligations, or other instruments that are based on or related to such mortgages” that were originated on or before March 14, 2008.

Because EESA gives the Treasury great flexibility in determining what assets may be purchased, and because EESA instructs the Treasury to consider purchasing “other real estate owned” (i.e. property owned by a lender after a foreclosure), it is also possible that the Treasury will purchase foreclosed properties from financial institutions.

               3.  How Will the Treasury Determine the Prices at Which to Buy These Assets?

The Treasury is directed to purchase the assets “at the lowest price that the Secretary determines to be consistent with the purposes of [EESA]” and to “maximize the efficiency of the use of taxpayer resources by using market mechanisms, including auctions or reverse auctions, where appropriate.” EESA also allows the Treasury to make direct purchases, if the foregoing “market mechanisms” are not feasible or appropriate. EESA forbids the Treasury from paying more for a troubled asset than the seller paid to acquire the troubled asset (or presumably, in the case of a mortgage, the amount of the loan).

The Treasury must issue program guidelines regarding methods for pricing troubled assets within two business days after its first purchase of troubled assets (no later than November 17, 2008).   

               4.  What Must a Financial Institution Give the Government to Participate in TARP?

A financial institution that is traded on a national securities exchange must give to the Treasury a warrant giving the Treasury the right to receive nonvoting common stock or preferred stock in the financial institution (or voting stock if the Treasury agrees not to exercise the voting power). A financial institution that is not traded on a national securities exchange must give the Treasury a warrant for common or preferred stock, or a senior debt instrument.

The financial institution also must agree to certain limits related to executive compensation.

         C.  EESA Instructs the Treasury to Establish a Program to Guarantee Troubled Assets.

EESA also directs the Treasury to establish a program to guarantee troubled assets. Very few details about the guarantee program were included in EESA, other than the mandate to establish such a program at the same time that a program is established to purchase troubled assets. EESA does not specify whether all troubled assets or only certain classes of such assets will be eligible for the guarantee program. Details of the pricing for the guarantee program are also sparse, but the act indicates that premiums will vary to reflect the credit risk associated with different troubled assets and must be sufficient to meet anticipated claims based on actuarial analysis.

More details related to the guarantee program can be expected in early 2009, as the Treasury must report to Congress on the guarantee program within 90 days after the date EESA was enacted.

III.  Will EESA Work?


The grand idea behind EESA is that if lenders could sell their troubled mortgage assets (or obtain guarantees covering such assets), then lenders would have the capital and the confidence necessary to begin lending again. The reason for the downturn in the real estate market (according to this theory) is that credit is unavailable to businesses and individuals, and if loans become available again, then the businesses and individuals will resume buying real estate. Whether EESA will actually work as planned remains to be seen, but one thing is certain: it will take some time before EESA has an impact on the real estate market.