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The original documents are located in Box 54, folder "1975/12/02 - Dr. John Dempsey and
David Froh" of the James M. Cannon Files at the Gerald R. Ford Presidential Library.
Copyright Notice
The copyright law of the United States (Title 17, United States Code) governs the making of
photocopies or other reproductions of copyrighted material. Gerald Ford donated to the United
States of America his copyrights in all of his unpublished writings in National Archives collections.
Works prepared by U.S. Government employees as part of their official duties are in the public
domain. The copyrights to materials written by other individuals or organizations are presumed to
remain with them. If you think any of the information displayed in the PDF is subject to a valid
copyright claim, please contact the Gerald R. Ford Presidential Library.
Digitized from Box 54 of the James M. Cannon Files at the Gerald R. Ford Presidential Library
MEETING WITH DR. JOHN DEMPSEY
DAVID FROH
Tuesday, December 2, 1975
11:30 a.m.
Mr. Cannon's Office
Put Toda
forcow up
FORD i LIBRARY GERALD
THE WHITE HOUSE
WASHINGTON
December 2, 1975
JMC:
Dr. Dempsey's office called
to say that the following people
will accompany him on his visit
with you today at 11:30:
Isaac Green
Mr. Fox
Dave Froh
p
THE WHITE HOUSE
WASHINGTON
REQUEST
December 1, 1975
MEMORANDUM FOR
JIM CANNON
FROM
TOD HULLIN
r
SUBJECT
MEETING WITH GOVERNOR MILLIKEN, DR. JOHN DEMPSEY
TUESDAY, DECEMBER 2, 1975, 11:30 a.m.
I.
PROBLEM
Many housing finance agencies (the Michigan State Housing
Finance Agency included) are facing severe financial
difficulty, primarily because of their inability to
raise capital on reasonable terms.
II. PROPOSAL
The Governor will urge you to expedite a proposal that
is being developed by Secretary Hills which authorizes
a co-insurance program of multi-family mortgages with
State and local housing agencies.
III. BACKGROUND
The Housing and Community Development Act of 1974
contained two provisions (Section 802) which could
benefit State housing agencies. One authorized the
Secretary to guarantee obligations issued by State
agencies and subsidize one-third of the interest on this
type of obligation. The other authorized the Secretary to
coinsure (with any mortgagee) single- and multi-
family mortgages where:
-- The mortgagee assumed at least 10 percent of the
loss on a mortgage;
-- The mortgagee carried out the underwriting functions;
-- Coinsurance volume could not exceed 20 percent of
either FHA single-family or multi-family insurance
for each fiscal year until October 1, 1977.
-2-
Since enactment, the Administration has strongly
opposed the use of the State bond guarantees and
interest subsidy authorities. Congress appropriated
$15 million of contract authority ($600 million
budget authority) for interest grant payments. The
President has proposed a rescission of this authority.
The Senate Banking, Housing and Urban Affairs Committee
has developed amendments to the mobile home bill which
amend the existing coinsurance authorities by:
-- Authorizing coinsurance where the mortgagee would
take an initial percentage (unspecified) of the
losses plus a share (not less than 10 percent)
of the remaining losses;
-- Removing mortgages coinsured with public housing
agencies from the 20 percent limitations.
Secretary Hills has proposed that the Administration
accept these amendments. OMB has concurred and the
Secretary should communicate our position to the Senate
later this week.
The proposed amendments will probably be passed by the
Senate and will probably be accepted by the House in
conference. This legislation should be to the President
before Christmas and the program could be in operation
by mid-February.
RECOMMENDED RESPONSE
I suggest that you listen and indicate that you will do
whatever you can to expedite HUD's proposal.
The announcement of Administration support for these
amendments should be done by the Secretary.
PROBLEMS CAUSED BY AN INABILITY OF STATE HOUSING FINANCE AGENCIES
TO RAISE CAPITAL THROUGH THE SALE OF SECURITIES
POSSIBLE CONSEQUENCES AND A PROPOSED SOLUTION
Prepared by:
Michigan State Housing Development Authority
December 1, 1975
The Problem
The state housing finance agencies (SHFA's) are the only presently
operational entities producing subsidized housing under the
provisions of the 1974 housing act. They face an immediate and
critical problem caused by an inability to sell the notes and
bonds which finance their operations because of an erosion of
confidence on the part of security buyers. Investors have stopped
buying, or are buying in grossly inadequate amounts, because of
generally unsettled economic conditions intensified by a
growth in the demand for capital at a rate substantially in excess
of the rate of expansion in the supply of capital, and compounded
by investor concerns about a New York City default and the UDC
difficulties. A rundown of specific state agency financing
difficulties is attached.
It must be emphasized that this problem did not result from a
recognition by the security market of a weakness in the statutory,
financial or organizational structure of state housing finance
agencies, or from a discovery that the heretofore favorable
investors' and rating agencies' analyses of HFA security offerings
had been faulty. Contrary to the HUD/FHA experience, the states
have consistently produced subsidized housing which works. These
successful developments are the underlying security and source of
repayment for SHFA securities, which therefore remain sound.
If a resolution does not occur quickly, many state agencies will
face default on the repayment of their share of one and three
quarters billion dollars of presently outstanding bond antici-
pation notes. Default could occur because of an inability to
roll these notes over, or replace them with long term bonds.
In addition, new capital is required if new starts are to take
place. If new capital is not available and the production pipeline
is turned off, a rapid winding down would occur. Competent,
experienced staff will leave. It would take years to rebuild the
development capabilities of SHFA's so that housing starts can again
take place. If there is widespread default on current agency
obligations, SHFAs may never be resurrected as a means of producing
housing.
Rationale for Assisting the SHFAs
The 1974 Housing Community Development Act specifically
assigned a role to the state housing finance agencies in the
delivery of subsidized housing. HUD, which does not presently
appear capable of sustained program activity, gave the states
the major role in implementing the housing component of the
1974 Act. In many instances it assigned more subsidies to
state agencies than to its own area offices. The state agencies
are geared up and able to produce substantial amounts of housing
if the flow of capital is assured. If however, the state
agencies become inoperative, no present feasible alternative is
available to fulfill the Administration's and Congress' goal
of producing subsidized new housing. Additionally, the cessation
of housing construction would negatively affect the economy of
the country with immediate consequences in terms of significant
increases in unemployment for construction workers and others
dependent on the shelter industry.
Proposed Solution
It would be unrealistic to rely on a spontaneous resolution in the
near future of the factors which have negatively affected the
SHFA's ability to sell notes and bonds. Since the financing
difficulties preventing the sale of securities are due to a lack of
market acceptance caused by factors unrelated to the financial
integrity of the SHFAs, the appropriate solution would be a method
of bolstering buyer confidence. Conversations toward an implementa-
tion of this objective have already begun with HUD. A proposal
has been formulated by a group of state agencies. It calls for
federal assistance within the framework of existing fiscal and
budgetary policies. The devices recommended do not require any
net cost to any federal agency, will not increase the total demands
for capital, and will in fact reduce federal outlays almost
immediately. It is not a subsidy or a bail-out. The proposal is
attached as Exhibit I. It consists of the following two basic
components:
1. FHA Co-Insurance. State agencies would continue to finance
housing production and would have the ability to underwrite
FHA insurance for this housing on a shared risk basis. This
concept is not new. It is presently authorized by legislation
and has been in the discussion stage for at least two or three
years.
2. Issuance of Government National Mortgage Association (GNMA)
Mortgage Back Securities. This is a procedure which would
allow the state agencies to utilize existing GNMA procedures
and guarantees. GNMA backing would provide a security
instrument which is well known and accepted in the securities
market and would thus enable state agencies to successfully
market their issues. In addition, it would open a large
new capital market to the state agencies. GNMA would have
no financial exposure since the underlying mortgages would
be insured by both FHA and the states. The state portion
would obviously have to be funded in an actuarially sound
basis so that no possibility of GNMA exposure would result.
The federal Treasury has traditionally resisted the piggy-
backing of federal guarantees and tax exempt financing. To
avoid this situation which would occur with a GNMA guarantee
on tax exempt bonds, it would be feasible to issue taxable
bonds under this proposal, since the GNMA guarantee by itself
would produce an attractive and workable interest rate
estimated at 8 3/4% today.
Conclusion
If the Administration intends to produce subsidized housing within
the next year and wishes to do so at the least possible expense to
the federal treasury, then speedy adoption of this proposal is
necessary.
FINANCING DIFFICULTIES OF STATE HOUSING FINANCE AGENCIES
New Jersey Housing Finance Agency: Recently able to sell $60
Million of bonds at approximately 9% only after resorting to extra-
ordinary measures including committing State funds to purchase a
portion of the issue. Several hundred million of notes outstanding.
Agency has ceased new housing production activity.
Massachusetts Housing Finance Agency: Recently able to sell bonds,
but only in the amount of $12 Million. Were able to roll over notes
only through emergency action of State Legislature. About $500
Million of bond anticipation notes outstanding.
Virginia Housing Finance Agency: Paid 8.78% to sell $30 Million
bond issue. Were able to renew only $15 Million of bond anticipa-
tion notes at 8.70%. Stopped applications and commitments.
Pennsylvania: Presently trying to sell $18 Million of a planned
issue of $30 Million. No new commitments being issued.
Wisconsin: No construction financing. Long term financing in
small cities subject to the sale of bonds. No big city lending.
Bond sale in October, 1975 for $11 Million at 8.40%.
Minnesota: Processing commitments subject to financing. Closing
with money already available. November bond sale of $18 Million
at 8.67%. Hope to sell $31 Million two-year notes at 7.00% in
December.
Illinois: Processing at developers risk. No assurance of commit-
ment. $130 Million short term debt due beginning September, 1976.
Sold $29 Million notes on November 4, 1975 at 6.25%.
New York - UDC: Problems well publicized. Attempting to build-
out developments already started.
New York - HFA: Mammoth note overhang. Going from financial
crisis to financial crisis.
Michigan: Withdrew a $25 Million bond sale because of no market
response. If another bond sale attempt fails, processing new
commitments will be suspended.
EXHIBIT I
COUNCIL OF STATE HOUSING AGENCIES
RECOMMENDATIONS
TO
U.S. DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT
CONCERNING IMPLEMENTATION OF EXISTING
FEDERAL ASSISTANCE AUTHORITY NEEDED
TO ENHANCE MARKETABILITY OF
HFA NOTE & BOND ISSUES
1025 CONNECTICUT AVENUE. NORTHWEST / SUITE 707-A / WASHINGTON. D.C. 20036 / PHONE: (202) 785-2146
SUMMARY
The State housing finance agencies are facing an immediate,
critical problem in selling the necessary volume of notes and
bonds at reasonable interest rates. If they do not succeed in
doing so, they will very soon be out of business as effective
delivery mechanisms for the production of low and moderate in-
come housing.
The Council of State Housing Agencies, therefore, urgently
recommends that HUD implement two programs to assist the HFAs
in solving this problem:
(1) Co-insurance (or partial insurance) by HUD/FHA of
HFA multifamily mortgages under Section 244, and
(2) Use of GNMA mortgage-backed securities for HFA
bond issues.
These two programs can be implemented quickly, under existing
legislation, at no cost to the Federal government, and with great
benefit to both the HFAs and HUD.
We have made various specific suggestions for how to imple-
ment these two programs, but we would be willing to discuss other
specifics for these programs or to explore other alternative pro-
grams.
In addition, we have identified several other possible
alternatives for Federal action, including the Section 802 bond
option. These alternatives each have drawbacks which make them
less desirable or effective for immediate implementation. How-
ever, the only significant negative element involved in the
Section 802 interest differential payments concept is that, not-
withstanding the inherent fiscal efficiency of the concept, the
continued use of this program implies continued Federal budget
appropriations. CSHA remains extremely interested in working with
HUD to implement the Section 802 program, and believes that it
can be employed effectively in conjunction with our major pro-
posals outlined above; however, we wish to direct HUD's attention
first to our two primary recommendations.
We have requested a meeting with the Secretary of HUD to
present our proposal, and ask to begin working with HUD immedi-
ately to implement our two major recommendations or other suitable
programs as soon as possible.
i
CSHA PROPOSAL TO HUD
Table of Contents
Summary
i
Table of Contents
ii
I.
INTRODUCTION
1
A.
Statement of the Problem
1
B.
Rationale for Federal Action
4
C.
Possible Consequences of Inaction
6
II.
MAJOR RECOMMENDATIONS FOR FEDERAL ACTION
7
A.
Co-Insurance of HFA Mortgages under Section 244
8
1. Eligible Agencies
9
2. Eligible Mortgages
10
3. Sharing of Risk Between HUD and HFAs
12
4. Method of Determining "Loss"
15
5. Co-Insurance Effective Upon Completion
16
6. Administration of Defaulted or Foreclosed
Properties
17
7. Payment and Use of Co-Insurance Premiums
17
B.
HFA Use of GNMA Mortgage-Backed Securities
18
1. Statutory Authority
20
2. Rationale for Use of GNMA Guaranty
21
3. Requirements for Agency Eligibility
22
4. "Pass-through" VS. "Bond-type" Securities
23
5. Potential for Project "Work-Outs"
23
6. Advance Commitments for GNMA Bond Guaranty
24
7. Combination with Other Alternatives
25
III.
OTHER POSSIBLE ALTERNATIVES FOR FEDERAL ACTION
26
A.
Taxable Bond Option under Section 802(c) (2)
27
B.
Guarantee of HFA Bonds under Section 802(c)(1)
29
C.
GNMA Purchase of HFA Mortgages ("Tandem Plan")
29
IV.
CONCLUSION
31
ii
I.
INTRODUCTION
Because of conditions which have developed in the municipal
bond market over the last several months, State housing finance
agencies are now in serious danger of losing their ability to
stimulate and finance the development of low and moderate in-
come housing. At its recent annual meeting in Chicago, the
Council of State Housing Agencies appointed a special task
force to prepare and present recommendations for prompt Federal
action which could assist in solving this critical problem.
Consequently, we submit for your urgent consideration our pro-
posal to utilize existing authorities of the Department of
Housing and Urban Development in order to restore the access
of State housing agencies to the capital markets at reasonable
interest rates.
A.
Statement of the Problem
The basic problem which HFAs face today is the inability
to sell their long-term bonds at reasonable interest rates; in
addition, the market has been unwilling to accept more than
small amounts of bonds at any one time, almost regardless of
rate. This situation has engendered serious investor doubts
about the ultimate ability of the HFAs to sell all the bonds
needed to meet even their present obligations (represented pri-
marily by bond anticipation notes presently outstanding in an
aggregate principal amount of more than $1-3/4 billion, together
with additional loan commitments of more than $1/2 billion). As
a consequence of these doubts, the market place has begun to re-
sist even short-term issues of bond anticipation notes, and many
HFAs are now wondering whether they can responsibly issue notes
for new projects, when they do not know whether, or at least at
what pace and volume, they can "roll over" or "take out" their
presently outstanding notes for projects already under construc-
tion.
Bluntly, the confidence of investors in the ability of
HFAs to market their bonds, in the volumes needed to pay off
their existing notes and at interest rates that keep the under-
lying developments economically feasible, must be restored as
quickly as possible. Until that happens, it will be extremely
difficult, if not impossible, for most HFAs to undertake any
new developments, including particularly the many thousand units
of Section 8-assisted housing as contemplated both by the HFAs
and by HUD. In the meantime, the risk that one or more agencies
may default on its notes, thereby becoming impotent for future
development activities and imposing an additional negative in-
fluence of potentially disastrous proportions on the market for
all HFA debt obligations, continues to increase.
It should be emphasized that the problems which this pro-
posal addresses do not result from a sudden recognition of any
intrinsic weakness in the statutory, financial or organizational
structure of the housing finance agency concept, or a discovery
that investors' and rating agencies' analyses of HFA debt of-
ferings have been faulty. These problems are, in reality, a
-2-
product of the general economic conditions at the present time,
intensified by a growth in the demand for capital at a rate
substantially in excess of the rate of expansion in the supply
of capital. These general conditions have obviously been com-
pounded by investor concerns about a possible default by New
York City and other recent difficulties in the municipal bond
market.
This situation has developed in spite of the fact that
the security being offered by the housing finance agencies
has not weakened during the past year. There still are not de-
faults on housing developments underwritten and financed by
HFAs. Established reserves remain intact. There is no evidence
that States will not meet the moral obligation being pledged;
in fact, the obligation has been met whenever and wherever called
upon, and there are additional examples of direct State support
in the absence of even a "moral" obligation. Nevertheless, in-
vestors have not been willing to continue the purchase of the
previous volume of housing finance agency obligations. Further-
more, the number of new issues being offered to purchasers of
tax-exempt bonds has increased substantially, resulting in a much
greater interest rate differential than previously existed be-
tween the various grades of municipal securities. This is evi-
denced by the fact that reasonably sized issues of top grade
tax-exempt bonds are still being sold at interest rates under
6%, while lower-rated HFA bonds are selling at 81/2% or more.
In this environment, State housing agencies are having rela-
tively similar experiences as they approach the capital markets.
-3-
Most agencies, offering sound real estate investments, reason-
able reserves, capable professional management and a State
moral obligation pledge as security for their bonds, are not
able to attract enough capital at a reasonable rate to carry
out the substantial production volumes of which they are ca-
pable and which they have found to be necessary and desirable
in their States. Moreover, the conditions which have brought
housing finance agencies to their current status are not likely
to be resolved by an improvement in general economic conditions.
Projections of long-term capital needs indicate that relatively
lower-grade securities will continue to have difficulty in at-
tracting investors. The continued operations of State housing
finance agencies, therefore, will require an improvement in the
perceived quality of the security being offered. Fortunately,
existing Federal legislation provides several alternative
mechanisms to accomplish this objective.
B.
Rationale for Federal Action
The Federal government, acting through HUD, should utilize
these mechanisms in order to preserve State housing agencies
as effective participants in the process of developing low and
moderate income housing. Federal involvement is necessary in
order to raise HFA debt obligations to a significantly higher
level of security in the eyes of investors. The issue, we sug-
gest, is not the soundness of the underlying mortgage loans or
the ability of the agencies to work out any difficulties which
may be encountered in specific developments. Rather, the ques-
-4-
tion is one of persuading the investor that his investment is
safe. With the wide range of alternative investments available
to him today, the bond buyer simply does not want or need to
take the time to analyze the underlying security for an HFA
bond issue. But the mechanisms we are proposing will give him
a readily identifiable security which in his mind is substan-
tially above that which HFAs presently can offer.
Federal involvement in preserving HFA capabilities is also
feasible within the framework of existing fiscal and budgetary
policies. The devices we are recommending do not require any
Federal budgetary outlays, will not produce any net cost to any
Federal agency, will not increase the total demands for capital,
and will in fact reduce Federal outlays almost immediately. We
are not seeking a subsidy or a bail-out. The use of the mechanisms
we are proposing will not cost the Federal government anything.
Federal involvement in solving this problem is warranted,
because State HFAs perform a vital role in the planning and de-
velopment of lower income housing needed to accomplish various
public purposes. These agencies have proven their capability
to initiate, complete and monitor high-quality multi-family
housing developments; they are a proven and effective delivery
mechanism, both for production of housing and for such "software"
activities as planning, coordination, technical assistance, and
experimental programs. Also, these State-level entities provide
a more local and flexible means of implementing housing policies
than is possible at the Federal level. The HFA mechanism is a
-5-
valuable, functional part of the balance of Federal and State
responsibilities under our system of government, and appropri-
ate action by the Federal government to preserve this mechanism
is wholly consistent with current Administration policies.
C.
Possible Consequences of Inaction
It is not an overstatement to say that the very existence
of HFAs as functional agencies is being seriously threatened
today. Unless State agencies receive assistance soon along the
lines we are proposing, the result is likely to be an increasing
risk of inability to meet outstanding obligations, the discon-
tinuance of processing of applications for future multi-family
mortgage loans, and the loss of. agency production capability.
Most HFAs are already anticipating severe difficulties in ob-
taining permanent financing at feasible interest rates for their
Section 236 and mixed-income developments which are under con-
struction or completed. It is absolutely clear that, under cur-
rent circumstances, State agencies will not be able to provide
the capital necessary to finance any significant portion of the
housing needed to utilize Section 8 new construction funds. This
will cause a further deepening of the housing recession with its
direct and significant impact on employment, put inflationary
pressures on the existing supply of housing, and generally serve
to impede any overall economic recovery.
The terrible aspect of this critical situation is that, if
the present opportunity to provide no-cost Federal assistance
and preserve the HFA vehicle is allowed to go by, the decision
-6-
may well be irreversible. Once the production pipeline is
turned off and competent, experienced staff is lost, it will be
extremely difficult, if not impossible, to rebuild the develop-
ment capability of State agencies; at best, it will literally
take years before housing starts occur again. And if there is
any widespread default on current agency obligations because
of the inability to sell bonds at acceptable interest rates,
HFAs will never be resurrected as a means of raising capital
for the production of housing.
On the other hand, prompt implementation of the available
options for Federal action will allow State housing finance
agencies to continue production at reasonable levels which can
be supported in local housing markets, with confidence that
they will be able to compete effectively for capital.
We respectfully urge your immediate efforts to effectuate
the recommendations which follow.
II. MAJOR RECOMMENDATIONS FOR FEDERAL ACTION
Of the many and varied alternative methods of Federal ac-
tion to assist the HFAs in raising capital which have been put
forward, we wish to recommend most strongly a combination of
two programs: (1) co-insurance by HUD-FHA of HFA mortgage loans
under the new Section 244, and (2) adaptation of the existing
GNMA "mortgage-backed securities" (MBS) program for use by HFAs.
Both of these options should have a substantial benefi-
cial impact on the marketability of HFA debt issues, while having
only a moderate restrictive impact on HFA program administration.
-7-
At the same time, the impact on the Federal government in terms
of risk, cost and other Federal policies would be modest, and
the potential volume under each option or a combination of the
two would appear to be of manageable proportions. Several
other options which do not measure up on all these points, but
which may still be desirable--perhaps for limited applications--
are discussed in section III of this report.
A.
Co-Insurance of HFA Mortgages Under Section 244
The most basic and urgent recommendation we submit is for
immediate development and implementation of a program of "co-
insurance" (or, perhaps more accurately, partial insurance) by
HUD-FHA of HFA mortgage loans pursuant to Section 244 of the
National Housing Act. We believe that such insurance, covering
a maximum of approximately 85% of the possible loss pursuant to
each of an agency's mortgage loans, would be of substantial as-
sistance by itself and also is the necessary prerequisite to
several of the other alternatives, especially the GNMA mortgage-
backed securities program.
Technically, § 244 authorizes the Secretary to insure
under any provision of Title II of the National Housing Act,
"pursuant to a co-insurance contract", mortgages which would be
eligible for regular FHA insurance under such provision. Be-
cause of the replacement cost approach to value used by most
HFAs, it is assumed that such mortgages normally would be in-
sured under either Section 220 (urban renewal and declining
areas) or Section 221 (other areas). The statutory provisions
-8-
of these sections (or other appropriate insurance sections)
would have to be met, of course, but some of the regulatory
requirements might have to be modified. For now, we will
leave the specifics of this matter to a later submission.
Suffice it to say that we believe this question is, with rare
if any exception, solvable.
1.
Eligible Agencies
HFAs wishing to utilize the co-insurance program would
submit a request for participation to HUD-FHA, and would also
request a total amount of co-insurance authorization. HUD-FHA
would review the agency's qualifications in terms of program-
related criteria, and notify the agency of its approval, if it
qualified, and its authorization amount. Upon approval of the
agency by HUD-FHA, the agency would continue to be authorized
to make mortgage loans eligible for co-insurance, up to the
dollar amount of its authorization.
The basic criteria for agency participation would be con-
siderations such as: (1) the ability of the agency to perform
mortgage loan underwriting; (2) the soundness of the agency's
underwriting in the past, to the extent applicable; and (3)
the significance of the financial risk to the agency if losses
are in fact experienced, so that the agency will have a strong
incentive to do careful underwriting. On the other hand, an
ability on the part of the agency to fully cover the uninsured
part of any loss should not be a requirement for program parti-
cipation, since HUD-FHA will not be liable for this portion of
-9-
the loss in any event. Practically speaking, the market place
will require sufficient assurances on this score, and HUD need
not become involved in this judgment as a condition of eligibility
for Section 244.
Once approved for Section 244 purposes, an agency would
function much like an FHA Title I lender. The HFA and HUD-FHA
would enter into a master co-insurance contract, pursuant to
which the HFA would originate, process, and close the co-insured
mortgage loans in its own name. Shortly prior to closing of
each loan, however, it would deliver to HUD a certificate of
compliance with the appropriate statutory criteria and a request
for execution by HUD-FHA of a certificate of co-insurance. (In
projects receiving Section 8 assistance this could be done si-
multaneously with submission of the Proposal.) The individual
project need not be underwritten at all by HUD-FHA and the co-
insurance certificate issued by HUD-FHA would be conclusive
evidence of the HUD-FHA's insurance obligation, once the loan
was actually closed.
2.
Eligible Mortgages
All multi-family mortgage loans made or purchased by an
eligible agency would be eligible for co-insurance under Section
244, except of course any loans already insured under other
sections of the National Housing Act. Subject to the comments
on page fifteen, advances on construction loans also would be
eligible for co-insurance. Co-insurance could be applied to
mortgage loans for projects that are not yet started, that are
-10-
in construction, or are already completed; projects that are
already "bonded out" would not be eligible, however, since the
HFAs have no need to raise further capital for such projects.
As discussed above, HUD-FHA could issue certificates to provide
co-insurance for specific project loans subject to closing of
those loans within the period of the commitments.
Under this approach, the maximum potential volume of HFA
mortgage loans which HUD might be asked to co-insure is probably
less than $5 billion. This includes the possibility of co-
insuring all of the HFA loans presently on BANs (sometimes re-
ferred to as the "note overhang") and also co-insuring HFA mort-
gages for new construction Section 8 projects (based on the HFAs'
estimated allocation of the FY75 and FY76 contract authority),
most of which projects are not yet committed by the HFAs. The
breakdown of the maximum potential volume is approximately as
follows:
Outstanding BANs as of 10/1/75
$1.757 billion
Commitments not on BANs
.658
Subtotal - ("Note Overhang")
$2.415 billion
FY75 Sec. 8 Projects Not Yet Committed
(est. at 20,000 units)
.500
FY76 Sec. 8 Projects (est. at 60,000
units)
1.500
Subtotal-Sec. 8 New Construction
2.000
TOTAL
$4.415 billion
(Note - Outstanding BANs and commitments from HDR of
10/6/75.)
This is almost certainly the maximum potential volume
through the life of the present statutory authority which ex-
pires June 30, 1977. A statutory amendment will almost cer-
tainly be needed very soon, however, to exempt HFA mortgages
-11-
from the 20% ceiling on co-insured vs. "fully" insured mort-
gages presently contained in Section 244(d)(2); however, an
HFA co-insurance program could be developed and implemented
for at least a few months before this ceiling became a problem.
3.
Sharing of Risk Between HUD and HFAs
We are proposing a formula under which the agencies first
must absorb all of the initial loss in connection with any
project, up to 5% of the original principal amount of the mort-
gage loan. Only if the loss exceeded this amount would HUD-FHA
have any liability under its co-insurance contract, and even then
the excess of the loss over the 5% level would be shared 90-10
between HUD and the HFA. In addition, HUD's liability could
never exceed 85% of the original principal amount of the mort-
gage loan. These rather stringent provisions, we believe, give
HUD very definite limits on its liability and also give the
agency a real incentive to do careful underwriting. In order
to give the agencies an incentive to try to work out problems,
rather than just collect on their co-insurance, we are also
proposing that they be given a dollar-for-dollar credit toward
their top 5% liability for any expenditures they make trying to
keep the project out of foreclosure.
Several examples are presented in Table I below showing
how this formula would work. In each case it is assumed that
the project has been sold at foreclosure for the amount indi-
cated to an arm's length purchaser who has paid cash for the
project.
-12-
TABLE I
EXAMPLES OF EFFECT OF HFA CO-INSURANCE PROGRAM
A
B
C
Original Principal
Amount of Mortgage
:
$ 2,000,000
$ 2,000,000
$ 2,000,000
Pre-Foreclosure
-0-
100,000
-0-
Expenditures by HFA
Plus
Mortgage Balance
2,000,000
1,500,000
1,950,000
At Date of Foreclosure
Plus
Foreclosure Expenses
50,000
50,000
50,000
Subtotal Less
2,050,000
1,650,000
2,000,000
Proceeds of Sale
-0-
750,000
-0-
"Insured Loss"
2,050,000
900,000
2,000,000
Less
HFA's Top 5%
100,000
100,000
100,000
Leaves
Co-insured Amount
1,950,000
800,000
1,900,000
Less Lower of 95% of
Co-insured Amount
or
1,755,000
720,000
1,710,000
85.5% of Original
Mortgage Amount
1,710,000
1,710,000
1,710,000
Additional HFA Share
195,000
80,000
90,000
Total HFA Share of Loss
340,000
180,000
290,000
(16.6%)
(20%)
(14.5%)
HUD Share of Loss
$ 1,710,000
$ 720,000
$ 1,710,000
(83.4%)
(80%)
(85.5%)
As can be seen, the HFA always will absorb at least 14.5%
of the actual loss and in some cases could absorb 20% or more
of the loss. HUD-FHA, on the other hand, will never have to
pay more than 85.5% of the loss or 85.5% of the original mort-
gage amount, whichever is less. In addition, the agency is always
-13-
better off to spend dollars to try to prevent a foreclosure,
up to the point where it has spent the full 5% or has concluded
that the project cannot be saved by spending the 5%.
In summary, we wish to emphasize two specific points:
a. We believe that the inclusion within our propo-
sal of the concept that an HFA will "participate" to the
extent of 10% in any loss in excess of the top 5% (with
the HFA assuming the entire responsibility for such ini-
tial 5%) creates a continuing incentive to the HFA to
perform the most professional job of underwriting possi-
ble in order to minimize any loss, rather than an incen-
tive to "write off" a project once the possible loss ex-
ceeds 5%.
b. We are proposing that the foregoing risk-sharing
formula be applicable to all co-insured HFA mortgage loans,
without any dollar limitation on the HFA's exposure as
to its overall loan portfolio. We suggest that this in-
tentional exclusion of any "stop-loss" provision estab-
lishes a continuing incentive to the HFA to apply the
same professional standards of underwriting, portfolio
administration and program management to each proposed
mortgage loan and to its aggregate portfolio.
(It may be necessary to amend the statute, by exempting
HFAs or co-insured HFA loans from the "direct proportion"
language of Section 244(a)(1), in order to allow HFAs to take
the top 5% of any loss as we are proposing; if it is concluded
-14-
that such an amendment is needed for this purpose, we will
cooperate with HUD in seeking the necessary Congressional
action. )
4.
Method of Determining "Loss"
We are proposing that HUD-FHA would make no insurance pay-
ments unless a project was foreclosed upon or a deed given in
lieu of foreclosure. The total "insured loss" could then be
calculated, with all expenditures by the HFA up to the date a
foreclosure action was filed or an "in-lieu" deed was received
counting toward the HFA's top 5%. As discussed above, the HFA
would have an economic incentive not to go to foreclosure, as
long as it thought the project could be reinstated.
If the agency concludes the project cannot be saved with-
out a substantial reduction in the project's debt but still
wants to utilize the housing, it should be allowed to accept a
deed in lieu of foreclosure or to bid in itself at the fore-
closure sale. The difficulty which arises here is that there
is no sure method to determine the market value of the property
at the date of sale. In order to protect HUD-FHA's interest
in this case, we would suggest that a public auction sale take
place in every case, even where an "in-lieu" deed is accepted,
with the project going to the highest bidder. If the HFA sub-
-15-
mitted the highest bid, it would keep the project; if not,
the project would be conveyed to the highest bidder and the
sale proceeds credited against the mortgage balance and costs
in arriving at the "insured loss."
5.
Co-Insurance Effective Upon Completion
It would be necessary to have a co-insurance certificate
in hand before the initial loan closing, in order to assure
the bondability of the project and thereby make the bond an-
ticipation notes (BANs) saleable. It may be possible, how-
ever, to provide that HUD-FHA's insurance liability would not
begin until the project was physically complete (and free
of all construction-related liens or claims). Most of the
HFAs believe they are capable of protecting themselves against
and solving any construction-related problems, and many have
already satisfactorily resolved difficult problems of this
type. Removing the construction risk would significantly re-
duce the exposure of HUD-FHA under its co-insurance obligation
and would probably be acceptable to most HFAs. We cannot yet
judge whether the note market will accept non-co-insured BANs
without imposing a substantial interest rate differential,
and SO we cannot recommend at the present time a delayed ef-
fective date, contingent upon project completion. We suggest
further joint exploration of this possibility, if it is of
interest to HUD.
-16-
6.
Administration of Defaulted or Foreclosed Properties
It is our specific intention that the responsibility for
working with projects that get into difficulty be solely that
of the HFA, as it is now with non-insured projects. Because
of the risk-sharing formula described above, the HFA would
have a positive incentive to advance its own funds to keep
a project out of foreclosure, as long as this was remotely
possible. It would be necessary, therefore, to ensure that
the agency was not in any risk of losing its co-insurance claim
by trying to work with the project and delaying the filing of
its claim. On the other hand, it would be specifically provided
that, if it became necessary, the HFA would be fully responsible
for accepting a deed in lieu of foreclosure, going through fore-
closure proceedings, auctioning the property, and undertaking
any other actions that may be needed. We expect that this fea-
ture of our proposed co-insurance program will be particularly
attractive to HUD, as well as being preferred by the HFAs.
7.
Payment and Use of Co-Insurance Premiums
The HFA would, of course, pay a premium for the co-insurance
of its mortgages by FHA. (We would suggest, for example, an
initial fee of ½ of 1% of the insured portion of the loan plus
an annual fee of 1/8 of 1% of the insured portion of the de-
clining principal balance.) The intention in establishing the
premium should be to make the program self-sustaining. After
sufficient experience had been obtained, it might be possible
to determine that the program would be actuarially sound with
-17-
a lower premium, and any premiums already collected in excess
of the level needed would then be refunded to the HFAs. The
agency would be responsible to FHA for the payment of the pre-
mium, although it would be allowed to include the cost of the
premium in determining its interest and service charges to its
borrowers.
Because the agency would be taking such a substantial por-
tion of the risk itself, and in order to minimize the increased
cost to the borrower, we believe that every effort should be
made to keep the co-insurance premiums as low as possible. We
are confident that an appropriate fee schedule can be worked
out with HUD-FHA staff once the basic structure of the program
is agreed upon.
B.
HFA Use of GNMA Mortgage-Backed Securities
The second major component of our recommendation is that
the existing GNMA mortgage-backed securities (MBS) program for
multi-family mortgage loans be adapted for immediate use by
qualified HFAs. Under our proposal, HFAs would continue to
issue their own tax-exempt bonds backed by pools of mortgages
as they traditionally have done, but the bonds would now be
backed also by a GNMA guarantee of the timely payment of prin-
cipal and interest. The major effect of adding the GNMA guaran-
tee to the HFA bonds would be to significantly lower the interest
cost on long-term capital - capital that will have to be raised
for lower-income housing development in one way or another even
if the GNMA backing were not to be available. Under the proce-
-18-
dure we are suggesting, GNMA would be fully protected against
loss in the event of default, partially by FHA co-insurance on
the underlying mortgages and for the balance of any loss by
guaranty fees and other assurances provided by the HFAs.
There should be absolutely no net cost to GNMA or the
Federal government for this use of the MBS program. This is
so for the following reasons:
(1) The same amount of long-term capital would have to be
raised from the nation's total capital supply anyway in
order, first, to convert the agencies' existing and com-
mitted short-term debt into long-term amortized bonds
and, second, to build the new construction Section 8
units which have already been authorized by HUD or have
recently been authorized by Congress. Thus, the HFA
MBSs would not be increasing capital demands and would
not raise the cost of borrowing by the Treasury or other
Federal government agencies.
(2) There would be no cost to GNMA if any defaults occurred
because of the co-insurance and HFA assurances to GNMA.
The co-insurance program itself, as discussed above, should
be self-sustaining through premiums, and the HFA guaranty
fees and assurances would have to be determined by GNMA
as adequate each time a bond issue was sold.
(3) The cost of administration of the program, which should be
relatively low, would be covered by an application fee
paid by the HFA at the time of each issue.
-19-
In fact, use of the MBS program in this way should
save money for HUD, since it would be the chief benefi-
ciary of the reduction in HFA borrowing costs. The vast
majority of the dwelling units for which permanent finan-
cing must be obtained are assisted by HUD under either
Section 236 or Section 8, and under the Regulations for
these programs a reduction in the permanent interest cost
will directly lower the subsidy cost per unit to HUD.
1.
Statutory Authority
Section 206(g) of the National Housing Act, added in 1968,
authorizes GNMA to guarantee the timely payment of principal
and interest on securities which are (1) issued by any issuer
approved by GNMA for this purpose and (2) based on and backed
by a trust or pool composed of mortgages insured under the
National Housing Act. The statute further provides that GNMA
shall collect from the issuer a reasonable fee for any such
guaranty and shall make reasonable charges for the analysis of
any trust or other security arrangement proposed by the issuer.
This statutory authority has been used to implement a
sizeable and very successful program of mortgage-backed securi-
ties issued by mortgage bankers for FHA-or VA-insured single
family loans. In addition, a somewhat smaller program has been
implemented for multi-family project loans, where there is
usually a separate issue of securities for each FHA-insured
project mortgage loan. Basically, we are proposing an adapta-
tion of the existing multi-family MBS program, to recognize
-20-
the HFAs as eligible issuers and to make it more feasible to
use pools of multi-family loans.
2.
Rationale for Use of GNMA Guaranty
The basic reason for the use of the GNMA guaranty on HFA
bonds, via the mortgage-backed securities route, is to improve
investor confidence in HFA notes and bonds. In theory, the
same combination of underlying protections (FHA co-insurance
with HFA reserves and the State moral obligation) could be
offered directly to the investors, and their security would
be the same as GNMA's. We believe that such a combination of
security elements would serve to improve the competitive posi-
tion of FHA debt obligations in the capital markets and increase
the volume of such obligations which could be absorbed; how-
ever, in light of current market conditions, we believe that
such a combination, without a more readily apparent security
device, would not achieve any significant improvement in the
interest rate at which such obligations could be marketed. The
addition of the GNMA guaranty to the HFA bonds should produce
a very significant decrease in interest rate, because investors
would immediately recognize the increased security level. Also,
an advance commitment by GNMA to guarantee the take-out bonds
should substantially reduce the interest rate on the interim
bond anticipation notes, since doubts as to the agency's ability
to market the ultimate bonds would be greatly alleviated.
As explained above, this guaranty would produce no net
cost to the Federal government. Using it would produce a much
lower interest cost on bonds which simply must be sold in one
-21-
way or another. If the State agencies are not able to convert
the existing $1.75 billion in outstanding BANs into definitive
bonds, it will destroy absolutely their ability to raise any
further capital for housing development. But in view of the
severe restrictions that the market is presently imposing on
the size of any one bond issue, it could take literally years
to work off this "overhang" and continuous brushes with the
brink of default are likely to occur. Use of the GNMA guaranty
would at least remove the risk of inability to sell bonds at
all, while greatly lowering interest costs, and it may also
help to some degree with the volume problem.
3.
Requirements for Agency Eligibility
GNMA would define certain minimum requirements for HFAs
to participate in the MBS program. In addition, each time an
agency wished to use GNMA backing for a particular bond issue,
it would have to satisfy GNMA that each mortgage loan to be
included was co-insured by FHA and that the HFA had sufficient
reserves or other means of covering the uninsured portion of
the particular bond issue. Alternatively, part or all of the
uninsured portion of the issue might be secured by a funded
State insurance program or as general obligations of the State
itself, where such authority exists.
In brief, the intention of this proposal is to protect
GNMA completely against any risk of loss; the HFAs recognize
that they will have to provide GNMA with adequate guaranty fees
and other assurances against loss. The specific mechanisms to
accomplish this goal would probably vary from State to State
-22-
and would best be worked out in discussions with GNMA.
4.
"Pass-through" VS. "Bond-type" Securities
The MBS program permits the securities sold to the investors
to take either of two forms: (1) a mortgage-like security in
which the monthly payment of principal and interest (less the
servicing fee and the GNMA guaranty fee) is "passed through"
to the investor each month; or (2) a "bond-type" security on
which interest only is paid semi-annually and the full principal
is paid at a specified maturity date. So far, all multi-family
MBSs issued by private mortgagees have been "pass-through" se-
curities, while FNMA and FHLMC have issued "bond-type" securities.
The "pass-through" securities are considered to have a
distinct marketing disadvantage in the taxable market, because
of the monthly payment feature; and such an instrument is com-
pletely unknown in the tax-exempt market. Use of the "bond-
type" security by HFAs, therefore, would be far preferable; it
would be feasible, because HFAs traditionally have combined
several mortgages, each making monthly payments of principal
and interest, into a single bond issue under which semi-annual
payments are made to the bondholders. The present administra-
tively-set restrictions on the use of "bond-type" securities
would have to be appropriately modified, but there does not seem
to be any statutory obstacle to using this route for HFAs.
5.
Potential for Project "Work-outs"
One of the serious disadvantages of the present multi-family
MBS program is that it leaves the mortgagee/issuers virtually
-23-
no flexibility to enter into forebearance or modification
agreements with their borrowers if the underlying mortgage loans
experience difficulty. The program requires, for economic rea-
sons, that any defaulted loans be assigned to FHA for insurance
purposes as soon as permissible.
In our proposed HFA version of the MBS program, however, we
believe that this problem can and should be avoided. The under-
lying mortgages will be co-insured, rather than fully insured
by FHA, SO that the HFAs will have a continuing loss exposure
and, under the co-insurance format we are proposing, they will
also have an incentive to advance cash to keep the projects
out of foreclosure. There should be no need, therefore, for
'any requirement in either the Section 244 regulations or the
MBS regulations that the co-insurance be called upon at the
earliest permissible date. It will be important to coordinate
the regulations and procedures under the two programs on this
point, but we believe this is possible and that the flexibility
needed to reinstate defaulted mortgages, wherever feasible, can
be maintained in an HFA-MBS program.
6.
Advance Commitments for GNMA Bond Guaranty
We are proposing that the GNMA backing be applicable only
to definitive bonds issued by HFAs, and we believe that this
will be of great assistance in enhancing the marketability of,
and thereby lowering the interest cost on, State agency bond
issues. We are not proposing to use the MBS vehicle for notes
issued to cover the construction period, because this would
involve GNMA in evaluating the construction risks and the ade-
-24-
quacy of the agency's coverage thereof, and also because this
does not seem to be necessary in the marketplace today. (In
addition, it is possible the FHA co-insurance might not be in
effect during the construction period, as discussed above.)
But there clearly has been a marketplace problem in issu-
ing BANs where the ability of the agency to sell the bonds
needed to ultimately pay off the notes is uncertain. In order
to alleviate this problem in cases where the ultimate take-out
is intended to be GNMA-backed bonds, we propose that GNMA issue
conditional commitments (or certificates of eligibility) to
HFAs for specific projects before the notes for those projects
are sold. These advance commitments, of course, would be con-
ditioned on the agency's continuing to meet the GNMA eligibility
requirements at the time of the bond sale and its providing at
that time the agreed-upon guaranty fees and other assurances
required by GNMA. Again, we believe that a mutually satisfactory
mechanism of this type can be worked out with GNMA staff based
on similar procedures in other programs. (It may also be neces-
sary, for mechanical reasons relating to the customary method
of selling bonds, to use GNMA "construction loan securities";
we are not requesting this and would work with GNMA staff to
avoid this route, if at all possible.
7.
Combination with Other Alternatives
As mentioned previously, the Section 244 co-insurance pro-
gram is an absolute prerequisite to use of the MBS program, since
by statute MBSs must be backed by mortgages which are FHA-insured,
FmHA-insured or VA-guaranteed. In addition, the multi-family
-25-
MBS program could, at the option of HUD, be combined with one
of the other alternatives discussed in the next section. For
example, the MBSs issued by the HFAs could be taxable bonds
receiving an interest subsidy under Section 802(c)(2), in order
to give the HFAs access to the corporate bond market. Or FNMA
could purchase the GNMA-backed HFA bonds and raise the funds
needed to do so in the corporate market. Either of these com-
bination routes would make additional capital sources available
to HFAs, while also serving to reduce the volume of tax-exempt
borrowings.
The obvious disadvantage of such combinations is further
complexity in designing and implementing a new program. We
are not enthusiastic, therefore, about such further combina-
tions, but we do think they could be made workable with a suf-
ficient effort. We would be most willing to develop them
further, if this is of substantial interest to HUD.
III. OTHER POSSIBLE ALTERNATIVES FOR FEDERAL ACTION
The following possibilities for Federal action are also of
interest to us, particularly the use of taxable HFA bonds coupled
with interest differential payments by HUD under Section 802(c)(2)
of the Housing and Community Development Act of 1974. At this
point in our investigations, however, they appear either to pre-
sent significant potential delays in implementation or to raise
major policy questions on which opinion is likely to be strongly
divided. Therefore, we are not including them in our major
recommendations at this time. We are most willing, however, to
-26-
explore any of these alternatives further (especially the Sec-
tion 802 taxable bond option), if they are of substantial in-
terest and appear workable to HUD.
A.
Taxable Bond Option under Section 802(c)(2)
The principal benefit of using taxable HFA bonds with
HUD grants to cover the higher interest cost would be to give
HFAs access to the corporate bond market. This should provide
some relief from the oversupply problem in the municipal bond
market, where the number of debt issues has been increasing
while some traditional investors have withdrawn from the market.
Because of the much larger amounts of capital which are generally
available in the corporate market, the severe limitation pres-
ently existing on the volume of HFA issues would be alleviated.
Also, because of the narrowing differential between taxable and
tax-exempt securities of similar quality and term, use of the
full 33-1/3% interest grant might actually produce a slightly
lower net interest cost to the HFA than a tax-exempt issuance.
Even on this basis, however, interest costs to the HFA would
still be high (probably between 7.5 and 9%), because there
would be no perceived improvement in the security of the in-
vestment.
We would strongly recommend that HUD take action to im-
plement the interest grant portion of Section 802 as soon as
possible, at least on an experimental basis. Ideally, it
should be coupled with the use of FHA co-insurance under Sec-
tion 244 and GNMA mortgaged-backed securities. In this event,
of course, the MBSs issued by the agencies would be taxable,
-27-
but because they would also be fully secured in the hands of
the investors, the net interest cost to the HFAs should be
much lower. We believe this combination approach could be
particularly useful in times such as the present, when the
municipal market is at its capacity, because it takes the
basic top-grade security recommended above and makes it sale-
able also in the taxable market.
We have not included Section 802(c)(2) as part of our
two basic recommendations, however, for three reasons:
(1) We are concerned that it will take much longer
to implement than the co-insurance and MBS programs, be-
cause there is no programmatic precedent which can be
adapted;
(2) It requires direct budgetary outlays, on a
continuing basis, and will therefore increase Treasury
borrowings; and
(3) Even if implemented right away, it would solve
only a small part of the present HFA "overhang" problem,
since the recent $15 million appropriation is probably
sufficient for only about $400 million of bonds.
Despite these drawbacks, we urge you to implement taxable
bond interest grants as quickly as possible, and we volunteer
to assist you in this effort. We simply do not want to have
the co-insurance and MBS proposals in any way delayed while
Section 802(c)(2) is being analyzed and implemented.
-28-
B.
Guarantee of HFA Bonds under Section 802(c)(1)
Obviously, a direct guarantee of HFA bonds by HUD would
be of major assistance with both the interest rate and the
volume problems. CSHA strongly supported the passage of this
legislation and still believes in this concept. We recognize,
however, the likely resistance of HUD and the Treasury Depart-
ment to use of this route. Also, Section 802(h)(2) appears to
require that any bonds receiving guarantees must be taxable,
which would presumably offset the advantage of the guarantee
in terms of interest rate. Therefore, use of the Section 802
(c)(1) guarantee as a practical matter would also require the
use of Section 802(c)(2) interest grants, which adds another
level of complexity and raises the policy concerns discussed
above relative to Section 802(c)(2).
C.
GNMA Purchase of HFA Mortgages ("Tandem Plan")
The Emergency Housing Act of 1975 added Section 313(h) to
the National Housing Act, which authorizes GNMA to purchase
"conventional" multi-family mortgages which either have a loan-
to-value ratio not in excess of 75% or are insured by a quali-
fied private mortgage insurer or a state insurance corporation
approved by GNMA. Few if any HFA mortgage loans could meet
these requirements at the present time (and to modify signifi-
cantly the loan-to-value ratio on such mortgage loans would
have severe programmatic drawbacks) and therefore this possi-
ble vehicle does not seem to us to be of any general help to
HFAs in the near future. Creation of more State insurance pro-
grams could change this situation.
-29-
Both Section 313(b) (part of the 1974 "Brooke-Cranston"
legislation) and Section 302(b)(1) (the older and more general
"Tandem Plan" authority) authorize GNMA to purchase mortgages
insured under the National Housing Act, which would include
mortgages co-insured under Section 244. The recent HUD ap-
propriations act includes $5 billion for purchase by GNMA of
mortgages under any part of Section 313. Conceivably, there-
fore, state agencies could insure their mortgages under Sec-
tion 244 and then sell them to GNMA under the Section 313(b)
version of the Tandem Plan for permanent financing.
But there are several serious problems in trying to use
any form of the Tandem Plan for HFAs:
(1) Section 302(b)(1) prohibits GNMA from purchasing
mortgages offered by a State instrumentality. (Perhaps
this problem could be solved by having the HFA sell its
mortgages to a third party, who would then re-sell them
to GNMA, if this process has some substance to it.)
(2) GNMA would then have to raise the necessary
capital to buy the mortgages. If it did so by issuing
MBSs in its own name, the interest rate could not exceed
approximately 7.25%, under Section 313(d)(1); if sold
on the open market, this would mean the MBSs would sell
at a very great discount. A similar discount problem
would be caused if GNMA re-sold the mortgages to FNMA.
Alternatively, GNMA could borrow from the Treasury or the
Federal Financing Bank, but this would increase Treasury's
need for capital. Another alternative would be for HFAs
-30-
to sell their own bonds, use the proceeds to purchase
GNMA-issued MBSs and pledge the MBSs to secure their
bonds; but, as the statute presently stands, this
would require the agencies to sell their bonds at
7.25%, less their own spread.
(3) Because there are many other calls on the $5
billion in Tandem Plan funds, this would at best be only
a partial solution for HFAs.
(4) The basic statutory authorization in Section
313 expires on July 1, 1976, except as to commitments to
purchase entered into before that date.
(5) Sale of HFA mortgages to GNMA would eventually
remove HFAs from the servicing of these mortgages. This
would reduce both their income and their ability to ef-
fectively regulate and monitor the management of their
developments. Again, we are not recommending this route
at this time, but would be willing to explore it further
with HUD and GNMA staff.
IV. CONCLUSION
State housing agencies are at a crossroads. Either they
will continue to be effective, responsive public bodies initi-
ating and financing the development of housing, or they will
shortly become relics of a bygone era. Which course they will
take is not entirely in their power to decide - HUD's action
or inaction in the very near future will in all probability
decide this issue for them.
-31-
We respectfully, but urgently, request immediate favor-
able action by HUD. We have put considerable time and effort
into exploring all possible vehicles for Federal action, and
we sincerely believe that the combination of FHA co-insurance
and GNMA mortgage-backed securities is the best route, con-
sidered from all points of view. We are more than willing,
however, to consider any changes in these two programs you may
wish to propose from the format presented above, or to explore
any other alternatives. We ask only that you respond to this
proposal as quickly as possible. We stand ready and willing to
begin working with you at the earliest possible moment.
-32-