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Lost Illusions or Lost Opportunities?: PACE Bonds Controversy

Property Assessed Clean Energy bonds were supposed to be the sure-fire way to provide finance for energy efficiency or clean energy projects in homes and office buildings.  Born in Berkeley, California in 2007, they were blessed by the 2009 American Recovery and Reinvestment Act.  So far, PACE bond financing has come from local taxes in Berkeley, the solid waste authority of Babylon, NY, or federal stimulus dollars. But in May, federal financial giants Fannie Mae and Freddie Mac, which hold more than half of the nation's home mortgages, refused to take on new mortgages for homes in the PACE program.  Then, the Federal Housing Finance Agency went even further, calling PACE bonds a safety risk.

 Why did the federal mortgage agencies balk?  Since the loans, or "assessments," run with the property, the current owner can repay them over many years.  Advocates insist that repayments are no burden since utility and fuel bills will drop due to PACE-financed improvements.

But local governments consider PACE liens to be tax assessments.  So, like other local property taxes, in cases of bankruptcy PACE bond repayments have first lien status and stand in line ahead of mortgage lenders.  It's this first-lien status that has Fannie and Freddie on the warpath.  As the FHFA put it, "First liens established by PACE loans are unlike routine tax assessments and pose unusual and difficult risk management challenges for lenders, servicers and mortgage securities investors…They present significant risk to lenders and secondary market entities, may alter valuations for mortgage-backed securities and are not essential for successful programs to spur energy conservation."

 Given the near collapse of the home-mortgage industry as well as Fannie's and Freddie's own near melt-down, averted with $163 billion from the Treasury, their hostility to anything that looks like new debt - even with a green pedigree and no evidence of increased financial delinquency by participants  - is hardly surprising.

 Nor is it surprising that PACE bond supporters have rallied, but with little success. A bill to compel the federal agencies to acquiesce to PACE bond holdings in their portfolios languishes in Congress. A Long Island Congressman urged Fannie and Freddie to establish a pilot project, but there has been no response.  The U.S. Department of Energy issued PACE program guidelines to create a more rigorous loan assessment process and offered to crunch energy performance data on properties with PACE loans in hopes of forestalling a Fannie and Freddie freeze out, but to no avail.  Meanwhile, the California Attorney General plans to sue, asserting that since his state's PACE programs run on local property taxes, the federal government cannot interfere.  Babylon, New York appeals to the court of public opinion, arguing that the agencies "redlining" less well-off homeowners unable to afford energy efficiency upgrades or solar power without PACE financing, and bravely proclaims it will continue its program.

 New York City's Greener, Greater Building Plan soon will generate demand for energy improvements in large commercial and residential properties.   A vibrant PACE program could be a force for market transformation, but it will be undermined if many home and apartment dwellers cannot afford energy upgrades without PACE financing.  How shortsighted.  As a National Renewable Lab report drily notes, "In general, state, municipal and utility loan programs offer attributes that are considered more favorable than those offered by traditional lending institutions.  These types of programs often provide long term, fixed rate loans and reduced consumer-transaction costs."

This on-target observation elicits two key questions.  First, what will it take to persuade the FHFA to lift its PACE embargo? It's unclear whether removing first-lien standing for this debt would prove workable or instead, drive investors away.  Still, there's more at stake than lien status if PACE dies.  Second, where could PACE programs turn if the FHFA remains implacable?  For funding at a scale that matters, localities like New York City need revenue streams greater than what is now available in federal stimulus funds - without raising local taxes or its own debt level.  Securitizing PACE debt is one way to get to scale and DOE's offer to guarantee PACE loans is another.  Also, economic development agencies could issue tax-exempt PACE bonds to allow property owners to keep down project costs.  Then again, maybe this train-wreck of federal energy and housing finance policies is just another lost opportunity to make buildings more energy efficient for a climate-friendly planet.