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Battling brushfires.

Battling Brushfires

Where there's smoke at a statehouse, there's usually fire--and Freddie Mac's state-relations unit will be there to lower the fahrenheit.

State legislatures are becoming increasingly sophisticated and assertive in their efforts to regulate mortgage finance. This trend holds significant implications for real estate finance. No longer intimidated by the complexities of the mortgage industry, more state lawmakers are taking an active interest in legislating in this area. To deal with the influx of legislation now directed at their business, many market participants are finding it critical to actively monitor and address state legislative developments.

The evolution of Freddie Mac's state-relations program during the past decade reflects one organization's on-going response to this trend. The unit's experiences in navigating the legislative seas of 50 different states may provide useful bearings for others preparing to embark on a similar journey.

This article will trace the development of Freddie Mac's state relations program and will demonstrate the growing importance of state legislation to mortgage finance. The challenges and the stakes are getting larger. States possess the legislative ability to impact mortgage markets profoundly--and swiftly. The unwary participant is most susceptible.


Chartered by an act of Congress in 1970, Freddie Mac was established to increase the money supply available to primary mortgage lenders and home-buyers nationwide. In 1980, recognizing the growing importance of state legislatures, Freddie Mac created a state-relations section within its government affairs department. The mandate for state relations was clear--maintain Freddie Mac's ability to do business in 50 states and the four territories.

In contrast to these ambitious goals, budgetary constraints on the state-relations program were considerable, making ingenuity its most valued asset. Starting from ground zero, an effective, but rudimentary, computerized database was set up for organizing and tracking state legislation. This system enabled the state-relations unit to review bills introduced anywhere in the country and then categorize and prioritize the various legislative initiatives. Freddie Mac's first state-relations manager, Jeff Hayman, took the computer system along as he traveled the states. Using this computer, he would access the database from hotel telephones, thus simultaneously lobbying legislators in one state while monitoring events in another. Working the states to establish name recognition and credibility, as well as to promote particular issues, the first state-relations section was, in effect, an organizational nomad.

While the computer system was the section's eyes, a network of industry persons and legislators were its ears. A standard rule dictated that the section consult a minimum of five industry members each week, sharing information on the legislative environment in their states. Over a period of time, an elaborate network of resource persons was established across the country. By using the computer system and the industry resource network in tandem, Freddie Mac was able to keep pace with state legislative activities nationwide.

Early challenges

Although boosted by its early successes, the state-relations group had its momentum interrupted by a series of formidable challenges. The specific issue was an effort by a number of states to eliminate or restrict due-on-sale clauses in mortgage contracts. Mortgages with due-on-sale clauses were assumable only if the lender elected not to exercise the existing due-on-sale clause. In the early 1980s, several states sought to restrict due-on-sale provisions. Freddie Mac saw these restrictions as seriously limiting its ability to control credit risk, increasing the possibility of default by an unqualified new holder of the loan.

In particular, events in Georgia and Minnesota during this time illustrate the growing pains inherent in establishing a state-relations program. Enacted on March 1, 1979, Georgia State Bill 1 declared that lenders could not, either directly or indirectly, "accelerate or mature the indebtedness secured by such real estate on account of the sale or transfer of such real estate or on account of the assumption of such indebtedness." The challenge in Georgia was one of the first real tests for Freddie Mac's state-relations group and it helped define its future role.

In order to make Freddie Mac's concerns about the Georgia law known, over a period of several months representatives from the state-relations section testified at legislative hearings and gave news briefings. Freddie Mac also participated in a number of industry panels, interacting with Realtors, mortgage bankers, thrift representatives and citizen groups. Despite these efforts, however, there was resistance to "outsiders" interfering in Georgia's affairs. Freddie Mac's attempts to underscore its importance in ensuring the state's access to mortgage capital went unheeded. The efforts of industry allies proved no more fruitful, as many lawmakers failed to appreciate the impact their legislation was having on mortgage lenders. Finally, having made its intentions known, Freddie Mac delivered a message to Georgia legislators by discontinuing loan purchases in the state.

The suspension lasted from February 26, 1980 until March 30, 1981. Only after the passage of House Bill 324 on March 24, 1981, did Freddie Mac re-enter the Georgia market. House Bill 324 removed the restriction concerning a lender's ability to accelerate and permitted acceleration in cases where a new borrower was found uncreditworthy. With the new statute, Freddie Mac regained the reasonable degree of economic security it needed for continuing business in the state.

In a move similar to that of Georgia's legislature, Minnesota outlawed due-on-sale clauses effective May 31, 1979. Employing the same tactics that would later be used in Georgia, Freddie Mac was compelled to stop buying Minnesota loans. (Although Georgia acted first to restrict due-on-sale clauses, Freddie Mac wound up suspending Minnesota purchases prior to Georgia--largely because it remained optimistic that Georgia law could be amended without a suspension.) From October 10, 1979 through May 8, 1981, Freddie Mac would not accept mortgages from Minnesota. It only resumed its purchases after a May 9, 1981 amendment passed that allowed lenders to accelerate a loan if the transferee was deemed uncreditworthy. Once again, economic pressure was required to effect a critical change in state legislation.

Despite the fact that the state-relations section was unable to secure the desired legislative outcomes on its own, its stature was bolstered by the show of corporate support. Furthermore, Freddie Mac had conveyed the gravity of its concerns to other states contemplating due-on-sale restrictions. Henceforth, state legislators were aware that certain due-on-sale provisions protecting lenders were essential for Freddic Mac's continued operation in their states. After the events in Georgia and Minnesota, states were more open to legislative suggestions from Freddie Mac's state-relations section. Ironically, Georgia and Minnesota, the only two states Freddie Mac suspended with regard to mortgage purchases, were also the home states of then President Jimmy Carter and Vice President Walter Mondale--a fact that may not have been lost on other states when questioning Freddie Mac's seriousness on the issue.

During its campaign to modify state due-on-sale restrictions, Freddie Mac relied on various alliances and tactics. Working with trade associations in a given state, Freddie Mac was often able to present lawmakers with a united industry front. Additionally, by virtue of its expert reputation on housing issues, it was not uncommon for a state to ask Freddie Mac to testify on proposed legislation. Appearing at a legislative session to inform lawmakers also presented an opportunity to influence them--a fact Freddie Mac tacticians appreciated when devising lobbying strategy. As the unit increased its visibility in state legislatures and solidified its contacts within the industry, Freddie Mac gained credibility and reliability as a major player at the state level. However, just as Freddie Mac's state-relations section was evolving, so was the ability of state lawmakers to introduce new issues affecting real estate finance and the secondary mortgage market.

In 1983, following New Jersey's lead, Massachusetts introduced legislation that addressed growing concern over liability for cleaning up environmental damage. The legislation in New Jersey had escaped Freddie Mac's detection until after passage, but advance warning was obtained about the situation in Massachusetts. Massachusetts Senate Bill 2046 clearly reflected the changing nature of legislative challenges for Freddie Mac's state-relations staff.

Massachusetts Senate Bill 2046, known as the Massachusetts Superfund Act, gave the state a priority lien (superior to all other claims on a property, including those of a first mortgage) to recover any state-funded clean-up costs for hazardous waste. The original version of the bill would have given the state a priority lien not only against a corporation's polluted property, but against its other property as well--provided such an action was necessary to recover clean-up costs. Often referred to as the "superlien" legislation, Freddie Mac was concerned with the particular provisions affecting residential property. Specifically, Freddie Mac opposed giving the state authority to seize a property for clean-up expenses without compensating the holder of the first mortgage. Freddie Mac argued that no prudent mortgage investor could accept this unqualified lender liability. Unless the statute was amended, Freddie Mac representatives indicated the corporation would cease buying mortgages from the state.

In fact, in October 1983, Freddie Mac suspended purchases of multi-family mortgages in reaction to the superlien legislation. Warning the state legislature that it would also stop buying single-family mortgages unless the law was amended by December 15, 1983, Freddie Mac succeeded in convincing the lawmakers to modify Senate Bill 2046. Amendments were passed that exempted all residential property from the state's superlien authority, giving first mortgage holders priority claim to their properties.

The Massachusetts legislation became a model for Freddie Mac to use when lobbying other states on similar environmental issues. When other superlien-related bills were introduced in the states, Freddie Mac suggested that the Massachusetts example serve as an appropriate guide, allowing for necessary adaptations for a particular state. With a viable legislative model to put forth, it was easier for Freddie Mac to advocate a position that preserved a legislative environment conducive to its operations.

Forging a network

Several subtle changes also took hold in the strategic outlook of the state-relations section during this time. Some basic lobbying methods remained the same, such as participating in industry panels and networking with other trade associations. However, there was now greater thought given to the long-range strategy of state relations. The section now stressed that no single, state issue was worth jeopardizing the corporation's future position and that the major objective was to form longer-term alliances in the legislatures and within the industry. The do-or-die urgency that surrounded early issues was replaced with a more subdued and deliberate approach, as greater weight was given to using intermediaries to promote Freddie Mac's position. Tactics also shifted away from personal appearances and direct lobbying toward greater use of the industry network. Establishing a model state for a particular legislative topic, as was done in Massachusetts with the superlien bill, became the standard operating approach for major issues.

Since the mid-1980s, the state-relations group has focused on building coalitions of industry contacts, allowing Freddie Mac to more indirectly influence legislative outcomes. Preserving the section's credibility within the industry and in statehouses is of the utmost importance. Over-hyping an issue can be damaging to one's political capital, a principle that guides Freddie Mac's state-relations section. Also, recognizing that alienating a legislator or industry ally on one issue can prove expensive over the long run, the state-relations group approaches each situation realizing that the department's future effectiveness is as much at stake as the vote on any particular bill. These basic precepts provide the foundation for all state-relations decisions on strategy.

Issues at hand

Several major issues are now emerging in the states, demonstrating the growing scope and sophistication of legislation now impacting the secondary market. The success of Freddie Mac's state-relations section in dealing with these new bills has been mixed. However, one constant has emerged, namely the unpredictability of what the next issue will be and where it will come from. One example of an unusual state-related issue involves the efforts of California and New Jersey to provide financial relief for veterans of Operation Desert Storm.

The Soldiers' and Sailors' Civil Relief Act of 1940 (SSCRA), further amended in 1942, was a federal law designed primarily to provide a stay of civil court proceedings to service members. A major feature of the 1942 amendments to SSCRA was the limitation of interest charged by mortgage lenders to 6 percent annually for loans incurred prior to active duty. (In 1942, interest rates were averaging 5 percent to 5.5 percent.) When SSCRA provisions were reactivated with the Persian Gulf War, Freddie Mac fully acknowledged the negative impact on mortgage institutions. Recognizing that lenders would lose the difference between 6 percent and the current market rate of roughly 8.5 percent to 9.5 percent, Freddie Mac agreed to reimburse its sellers and servicers for the difference in rates. (Fannie Mae also adopted a similar policy.) However, California and New Jersey, seeking to provide additional debt relief beyond federally mandated assistance, promoted legislation that Freddie Mac saw as an excessive burden on mortgage lenders.

California Senate Bill 1, California's own version of the federal Soldiers' and Sailors' relief bill, was introduced on December 3, 1990. Although several amendments were subsequently added, the original bill was short--too short, in that it left many questions unanswered. The bill provided for members of the United States Military Reserve from California, who were called into active duty as a result of the Iraq-Kuwait crisis, to delay payments on mortgages and other obligations.

The original bill raised numerous questions that Freddie Mac asked the bill's sponsor to clarify. What was going to happen to the tax and insurance escrows? Would the U.S. Treasurer and the insurance company demand payment from the lender, even though the lender was not getting the money from the reservist? Could any reservist get the benefit? How is "reservist" actually defined? And why does a reservist not have to prove that he or she has been "materially affected" by a loss of income--a component of the federal Soldiers' and Sailors' Civil Relief Act? Also, in what period of time would the reservist reimburse the lender?

Most of these questions were ultimately answered after several amendments were adopted at the urging of industry groups in California. Working closely with the California Mortgage Bankers Association (CMBA) and several other industry groups, Freddie Mac and its allies engaged in a campaign of letter writing and telephone calls to the bill's sponsor. Meetings also took place in the state between Freddie Mac and California MBA representatives, the bill's sponsor and other committee members and their aides. Although the sponsor still pushed the bill, he proved more receptive to making substantial changes after hearing the industry's point of view.

The bill as passed requires a reservist to provide proof that his or her income was reduced to 90 percent or less of what it was prior to active duty; suspends only principal and interest payments; and allows for repayment over a seven-year period. The final version is far more palatable than was the original bill.

Although the outcome of the New Jersey bill remains undecided at this time, it appears likely it too will become law. New Jersey entered the fray with Senate Bill 3181. New Jersey lenders quickly formed a coalition and invited Freddie Mac's state shop to participate in working out more acceptable language. (It was clear in both California and New Jersey that the politicians were going to "make hay" with this hot issue. No one was going to want their name associated with a "no" vote on such a sensitive topic.) The legislators accepted all modifications and, as this article went to print, the bill was sitting on the governor's desk awaiting his signature.

More hot spots

Clearly, some significant political damage to Freddie Mac might have been the result of an all-out effort to defeat these bills--viewed as they were as a patriotic gesture of goodwill. So despite some compelling economic concerns, these political reservations prevailed in setting the strategy. Nonetheless, changes to the bills were made that significantly reduced their negative elements.

Another state-based issue currently making the statehouse rounds deals with liens by condominium associations for unpaid, common-area expenses. In those states that have passed the Uniform Condominium Act (UCA), condo associations can place a priority lien on a unit for up to the first six months of unpaid dues. Such a measure protects both the association and the holder of the first mortgage. However, when economic circumstances turn sour, as with the recent recession, it is not uncommon for a homeowner to discontinue paying the association while staying current with mortgage payments. The lender, who continues to receive the scheduled monthly payments for the mortgage, is often unaware of the delinquent condominium association dues. In the meantime, the association may, where state law allows, place a lien on the unit.

Several states have put forth legislation in an effort to assist community associations suffering from unpaid dues. Under these bills, an association could establish a priority lien for periods in excess of six months of past due assessments. The idea is that a larger claim by an association will pressure a lender to foreclose on a homeowner who is delinquent with dues, giving the association the necessary leverage to protect its income stream.

These bills present several dangers to a lender. For instance, a homeowner who pays his or her mortgage, but omits paying association dues, could go undetected until the association's lien has grown large enough to substantially impact the property's value. Furthermore, lenders might be forced to foreclose on a unit that has depreciated substantially, saddling the lender with an unwanted property, despite the fact that the unit owner had been paying the mortgage. The ability of a lender to work out a reasonable alternative to foreclosure is severely limited by these bills.

An example of one such bill is Rhode Island House Bill 6534. This legislation was passed in spite of Freddie Mac's objections outlined in a letter to the chair of the House Corporations Committee. Now, a foreclosing lender in Rhode Island must pay up to five years of unpaid homeowners' association dues, rather than the six months allowed under the UCA. In this case, it was difficult to establish a concerted effort to amend or defeat the bill, because it stalled for two months, then moved so quickly it passed before Freddie Mac knew it had been revived. The issue of condominium liens will most likely attract more attention as the condominium market continues to deteriorate.

Spotlight on SMMEA

Currently, the issue at center stage for state relations is the efforts of several states to override the Secondary Mortgage Market Enhancement Act (SMMEA) of 1984. SMMEA, enacted by the U.S. Congress to facilitate housing finance, contains a provision that pre-empted state regulations limiting the ability of investors, such as insurance companies, to invest in mortgage-related securities (MRS). Under SMMEA, MRS that are rated double-or triple-A, or are issued or guaranteed by Freddie Mac or Fannie Mae, are permissible investments to the same extent as obligations issued by the United States. However, the federal law contains a provision that enables states to override SMMEA by October 3, 1991 and impose their own restrictions on MRS investments. Several states have acted on this measure and have set limits on the volume of affected mortgage securities an investor may buy. In some cases, the new state limits are overly restrictive and, as a result, threaten to curtail the flow of mortgage funds into the state. Freddie Mac, along with other members of the mortgage finance, securities and insurance industries, has been an outspoken opponent of these new state law restrictions.

As this article went to print, approximately a dozen states had overridden SMMEA. However, most of these states recognized the high quality of Freddie Mac securities in their laws. For example, Kansas overrode SMMEA but immediately put language into its state law that restored the original MRS investment guidelines. With respect to other states that have approved overrides of SMMEA, when their legislatures return to session, Freddie Mac will move to get language introduced that provide for reasonable limits on MRS investments. In the meantime, New York remains the most crucial and pivotal state in the process of completing action on a SMMEA override.

New York's decision on SMMEA is critical for several reasons. First, New York, unlike most other states, regulates all insurance companies that do business within its borders, not just those domiciled in the state. Thus, New York laws on insurance investments, such as mortgage-related securities, carry a substantial financial impact. Second, with regard to insurance regulations, New York is largely viewed as a bellwether state. Third, and directly related to its status as an insurance leader, there is the opportunity to use New York legislation on SMMEA as a model to be followed by other states.

If the legislation that was passed by both houses in July is signed by the governor, then New York Assembly Bill 6753 will override SMMEA. While the bill does place new restrictions on MRS investments, it is being hailed by the insurance company investment community as an effective compromise. Current New York law restricts the amount that an insurance company can invest in the securities of any one issuer to 10 percent of the company's assets. Assembly Bill 6753 raises the 10 percent limit to an 80 percent aggregate cap on MRS. (Up to 70 percent can be invested in obligations of Freddie Mac or Fannie Mae, or double-A or triple-A rated MRS, while an additional 10 percent can be invested if, for every 1 percent of MRS, a corresponding 2 percent is invested in U.S. Treasuries.) While the pending bill still represents a compromise, it substantially enhances previous MRS investment guidelines. In the meantime, Freddie Mac views the situation in New York as an ongoing process and hopes to eventually have its securities recognized as government obligations. Given the high quality of Freddie Mac securities, its mortgage-related securities are an effective means for insurance companies to strengthen their investment portfolios.

Freddie Mac's state-relations section spent a great deal of time educating legislators and insurance regulators in New York about the safety of Freddie Mac securities, as well as the importance of securitization in today's housing finance market. With the passage of Assembly Bill 6753, it now appears those efforts and the efforts of others in the industry have paid off.

Continued state scrutiny

Surveying the legislative experiences of the past decade, it is readily apparent that many states are assuming a greater role in regulating mortgage finance. As a general rule, it appears that states are most proactive in this area during moments of economic distress. Whether attempting to protect local thrifts, homeowners or service members, state legislatures tend to take the initiative when a particular constituency appears in need. Beyond genuine motives of goodwill, this behavior is entirely predictable. The social utility of a program notwithstanding, most elected policy makers are still in the business of winning votes. Accordingly, state legislatures deserve special attention during hard times, because one lawmaker's "remedy" may turn out to be someone else's ailment.

Freddie Mac's experience in state relations can be a valuable resource for other industry members to draw up on. Lauren Meservey, director of Freddie Mac's state-relations section and Mary Burt, the group's senior legislative analyst, welcome the opportunity to work with other industry members on mortgage finance issues emerging in the states.

Freddie Mac's growing involvement in state affairs reflects the increased importance state lawmakers are assigning to issues affecting mortgage finance. The extent to which this trend impacts each participant will vary, but one thing remains fairly certain. Ignoring state legislative activities is fast becoming a luxury no one can afford.

Stephen A. O'Connor is a member of Freddie Mac's state-relations section. He had dealt with real estate finance issues since 1986. He would like to thank Mary Burt for her assistance with this article.
COPYRIGHT 1991 Mortgage Bankers Association of America
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Copyright 1991 Gale, Cengage Learning. All rights reserved.

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Title Annotation:Federal Home Loan Mortgage Corp.'s state-relations program
Publication:Mortgage Banking
Article Type:Cover Story
Date:Aug 1, 1991
Previous Article:A new congressional order.
Next Article:Holding the line.

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