Housing and Tax Reform – It’s Complicated

By KENNETH R. HARNEY

Nov 30, 2012

What would happen to home values in the event that popular real estate deductions for mortgage interest and local property taxes were cut significantly? It’s an issue you’re likely to hear more about as Congress and the Obama administration wade deeper into “fiscal cliff” and comprehensive tax reform negotiations heading into 2013.

Some of the forecasts are scary: Any significant reductions in these long-established tax benefits would inevitably trigger declines in home values. Under some circumstances, they could be well into the double digits – 15 percent, according to Lawrence Yun, chief economist of the National Association of Realtors. “That’s how much we can expect values to fall as buyers discount the value of the deduction in their purchase offers,” Yun says.

Other projections are more nuanced: Yes, cutting back on real estate write-offs could make homes less attractive financially, but other potential features of a final tax compromise could counteract the loss of deductions, softening the net impact on values. Plus no one on Capitol Hill is talking at the moment about eliminating the mortgage interest or property tax write-offs, just capping them in some way for higher-income individuals.

So what can you believe? Here’s a quick overview of what is inherently a complicated subject. Start with the basics. Both President Obama and some Republicans hinted during pre-Thanksgiving preliminary fiscal discussions that they might be open to raising revenues in part by limiting unnamed deductions and “loopholes” in a tax reform package next year.

When it comes to deductions for taxpayers who itemize, there are hardly any bigger than the mortgage interest write-off ($90-plus billion a year in revenue costs to the Treasury) and local real estate property taxes (roughly $20 billion a year). They are perennially high on the list of reformers who seek to streamline the sprawling federal tax code.

For much of his first term, President Obama advocated putting a cap on deductions by upper-income taxpayers – singles with more than $200,000 in adjusted gross incomes and joint-filing married couples with income in excess of $250,000. Under Obama’s plan, these taxpayers could not take deductions beyond the 28 percent marginal bracket level, even though they might be in the 33 percent or 35 percent brackets. Mortgage interest, real property taxes, charitable and other write-offs would be affected by such a cap.

But would limiting real estate deductions necessarily lead to lower home prices? A 1995 study by the consulting firm Data Resources Inc. estimated that a consumption-based “flat tax” that repealed all deductions would lead to a 15 percent aggregate decline in home values, costing owners $1.7 trillion in equity holdings.

More recently, a 2010 study for the Tax Policy Center of the Brookings Institution and the Urban Institute sought to model the effects of Obama’s tax reform proposals for fiscal 2011 – limiting mortgage interest and property tax deductions to the 28 percent bracket level, and the simultaneous increase in the highest-income tax brackets back to the levels existing before 2001. In one scenario, when taxpayers in the 33 percent bracket had their mortgage interest deductions limited to 28 percent, with no other tax changes, housing values dropped by 6.9 percent to 15 percent, according to the study. The restrictions would have the heaviest effects on houses in areas of the country with relatively high local tax rates and where the costs of renting a home or apartment are favorable when compared with the costs of purchasing – including California and portions of the East Coast.

The author of the study, Benjamin H. Harris, said in conclusion that “while none of the president’s proposed tax reforms are directed at changing the value of housing, it is clear that under certain assumptions, the proposals would have dramatic effects on housing prices.”

The reference to “certain assumptions” is key here. Nobody knows what shape tax reform – if it occurs in 2013 – will take: How drastically housing benefits are pared back, how long a transition period is provided, and what other elements in the final deal might serve to cushion the impact on homes, such as by spurring more vigorous economic growth, lower federal deficits and debt.

But for a segment of the economy such as housing, where asset values are tied in part to long-standing tax subsidies, almost any change that reduces those benefits appears likely to have at least a mildly negative effect on pricing.

That is what is now in play on Capitol Hill.

Housing Policy Talks Should Start with FHA, DeMarco

By Joe Adler

NOV 28, 2012 4:25pm ET

WASHINGTON – As policymakers mull the future of U.S. mortgage policy, Federal Housing Finance Agency chief Edward DeMarco sees a potential starting point in an entity he does not regulate: the Federal Housing Administration.

As part of an update on recent FHFA activities, DeMarco, the agency’s acting director, told a gathering of policy leaders that figuring out the FHA’s role in a future housing finance system could help frame the debate over the extent of the government’s long-term involvement in mortgage lending.

“One potential place to start is by clearly defining the role of the traditional government mortgage guarantee programs like the Federal Housing Administration,” DeMarco said in a speech to the Exchequer Club. “If policymakers begin with the role FHA should play in the future in terms of what borrowers would have access to this program, and what structural changes might be needed, then it would be easier to consider the government’s role in the remainder of the mortgage market.”

In his wide-ranging remarks, DeMarco, who has at times butted heads with the White House over mortgage-related policy, said he essentially will stay on the job if the administration will have him. He also sounded an optimistic tone on recent positive signs about the housing recovery, and touted a sharp rise in homeowners helped this year through a government refinancing program compared to 2011.

“In the first nine months of this year, 75% more borrowers benefited from” the Home Affordable Refinance Program “than did in all of 2011,” DeMarco said. “It is possible that the program could reach nearly a million borrowers, or more, by the end of the year. In addition, over 40% of the HARP refinances in 2012 have gone to underwater borrowers, and an increasing percentage of HARP refinances in 2012 were for shorter term mortgages that help borrowers build equity faster.”

But DeMarco reiterated that the government should be cautious about the amount of subsidies it provides to the mortgage market in any future housing scheme.

Following his remarks on the FHA, which provides an insurance guarantee on privately-originated mortgages, DeMarco said the FHFA is not the only agency with the potential to help steer mortgage activity away from the U.S. government.

“FHFA is taking a number of steps – whether it is increasing guarantee fees or pursuing risk sharing alternatives – that have the potential to transfer some credit risk to the private sector,” DeMarco said. “We will continue to try to make progress in this area, but if policymakers are serious about limiting the government’s role, more direct actions may be needed to have significant near-term effects.”

DeMarco provided little detail on what he thinks should be the result of discussions about the FHA’s future, though in response to an audience question he suggested one issue policymakers should address is the size of FHA loan limits, which in certain high-cost areas are higher than the conforming loan limits imposed by Fannie Mae and Freddie Mac. Generally, DeMarco said the government should answer the question, “What is the public purpose of having American taxpayers providing explicit guarantees?” as well as who are the appropriate beneficiaries of such a subsidy.

“It very much needs to be part of the discussion,” he said.

DeMarco said improvements made to HARP last year – intended to make the program available to a larger pool of borrowers – have begun to pay dividends. Through September, he said, over 700,000 homeowners have been able to refinance loans through the so-called HARP 2.0.

“We continue to meet with lenders to ensure HARP is helping underwater borrowers refinance at today’s historical low interest rates,” DeMarco said. “As we continue to gain insight from the program we will continue to make additional operational adjustments as needed to enhance access to the program.”

Meanwhile, recent data suggesting that home prices are rebounding are encouraging, he said.

“I am cautiously optimistic that the signs of stabilization – and in some places, strength – that have started to emerge in certain sectors of the housing market are signals that its recovery is underway,” DeMarco said.

But he said the heavy involvement of the U.S. government in housing finance – illustrated by the extended federal conservatorships of Fannie and Freddie – is still reason for pause.

“Today, the government touches more than 9 out of every 10 mortgages. With this in mind, it is essential that we transition the mortgage market to a more secure and sustainable and competitive market,” DeMarco said. “The conservatorships of Fannie and Freddie were never intended to be long-term solutions. They were primarily meant as a ‘time out’ for the rapidly eroding mortgage market – an opportunity to provide some stability while Congress and the administration decided on how best to rebuild our housing finance system.”

There has been some speculation the administration may consider replacing DeMarco. Yet asked by an audience member if he intended to stay at the agency until a permanent director is confirmed, DeMarco indicated he does not plan to go anywhere voluntarily.

“I will continue to pour everything I can into this job so long as the president has asked me to be the acting director,” he said.

The IRS Gives Mortgage Technology a Boost

By John Adams

NOV 26, 2012 1:43pm ET

The Internal Revenue Service doesn’t typically leave people in a thankful mood, but proponents of electronic mortgages should feel downright cheery over a new IRS rule that goes into effect in a little more than a month.

On January 7, 2013, the IRS will begin accepting electronically-signed 4506-T and 4506-EZ documents, or the income verification forms that are part of the processing of almost every mortgage and loan modification. It’s a subtle adjustment that doesn’t endorse any specific technology, yet it will have a major impact on the quest to remove paper and time from the mortgage process, since the use of electronic signatures for income verification can also lead to greater use of digital signatures in other parts of mortgage lending.

“This will be a real boon for lenders and for consumers, this has been a real bottleneck,” says Christine Pratt, a senior analyst at Aite Group.

IRS forms 4506-EZ and 4506-T are requests for transcripts of tax returns, and are used to vet a borrower’s ability to pay off a loan, as well as to protect from fraud. The transcripts verify the income information that has already been submitted to the lender. The forms cover any type of loan, but are normally used for mortgages. Through its Income Verification Express Service (IVES) the IRS charges $2 per transcript, and lenders often hire third-party vendors to handle the IVES income verification process.

“Income verification has always caused considerable pain in the effort to remove manual steps from the mortgage process,” Pratt says. “This is certainly a very strong step in the direction of making electronic processing more of a reality.”

The new IRS rule won’t necessarily lead to the development of new technology, but will allow existing electronic signature technology to be used to execute income verification, and open the door to broader use of electronic signatures to transmit documents between borrowers and lenders, which can speed processing since the parties don’t have to be in the same location to sign documents. Mortgage lenders and technology companies had lobbied the IRS to allow electronic signatures for income verification, since the inability to do so has caused some lenders to avoid using electronic signatures for any mortgage documents.

Broader use of electronic images can save closing time, and may also improve accuracy, since all parties typically will access the documents from the same centralized location online for viewing and for electronic signatures. The providers of the technology that enables paperless processing obviously smell a renewed opportunity to spread the use of digital documents.

“We’ve been talking about paperless mortgages ever since Fannie Mae introduced SmartDocs [and industry standard for electronic mortgage documents] a number of years ago,” says Tim Anderson, director of electronic servicers at DocMagic, a loan document compliance company, who adds there have always been lingering legal documents that required paper signatures.

“With this new rule, for the first time, for all initial disclosures, virtually every one of the associated documents can be paperless. [Income verification] was one of the critical documents that was still paper-based.”

Another company, eSignSystems, a division of Wave Systems (WAVX) and a participant in the Mortgage Bankers Association’s IRS-related workgroup, said it was prepping its clients to add digital signature technology to the income verification request documents, a migration that will also further automate existing digital signature processes.

Anderson says fully paperless processing still isn’t at the finish line. Many closing documents must still be signed on paper. “Right now the FHA does not accept electronically signed closing documents. But now that the IRS has stepped up, there shouldn’t be an excuse for the FHA to not get on board with electronic signatures soon.”

Home equity protection insurance yanked off the market

No explanation from backers, including venture capital firm Kleiner Perkins

By Ken Harney

November 21, 2012

Its Silicon Valley venture capital backers saw it as a game-changer for real estate, and envisioned themselves picking off $250 million a year out of a potential $25 billion market: insurance policies that would protect the nation’s homeowners from one of their deepest fears — further losses in their equity.

Known as “Home Value Protection,” the plan was featured on CNBC, FOX Business and publicized in news articles across the country.

As recently as June 20, Scott Ryles, chairman and CEO of the company that developed it, San Francisco-based Home Value Insurance Co., told journalists at the National Association of Real Estate Editors’ annual conference in Denver that despite continuing home value declines in many local markets, his policyholders “have financial protection and peace of mind knowing they are insured against a housing market that continues to prove difficult to predict.”

First introduced in Ohio last fall — followed by Oklahoma, Georgia, Indiana and expected to be available nationwide pending state insurance licensing approvals — the plan looked like another winner for Kleiner Perkins Caufield & Byers, the legendary venture capital firm. Based in Menlo Park, Calif., KPCB was an early investor in Google, Amazon, Intuit, Genentech and dozens of other high-flying startups.

But earlier this month, the home value protection bandwagon suddenly stopped rolling. Independent insurance agents in the states where policies were being offered received emails, followed by form letters, that shocked them. They should not write any additional equity insurance, agents said they were instructed, because the home value protection plan was being suspended. The company would service policies already underwritten, but no new policies would be accepted.

Larry Brown, president of the Overman Insurance Agency in Cleveland, Okla., said he tried to contact Home Value executives by phone to get an explanation for the abrupt cessation, “but I couldn’t get through” to anyone.

Neither could I. Despite numerous emails and phone messages last week seeking comments or a statement from the company, no one responded. I tried getting information from one of Kleiner Perkins’ two members of Home Value’s board of directors, Randy Komisar, but an assistant said there would be no comment.

So we don’t really have answers on key questions: Why did this once ambitious, seemingly well-funded company stop offering equity protection to homeowners? How many policyholders did it insure from last fall through June? After a period of “suspension,” are there plans to bring it back?

Bill Duckworth, CEO of Fennell & Associates, an independent insurance agency in Oklahoma City, says if they do restart underwriting, he’s not sure he’ll offer the product. “The credibility is pretty much evaporated” in the wake of the sudden shutdown, he told me in a telephone interview.

Though the stone wall of silence prevents obtaining the company’s analysis, the timing of the equity insurance venture — and the limitations of the coverage itself — may offer some clues as to what went wrong.

At first glance, introducing an equity insurance plan toward the end of the worst real estate down cycle since the Great Depression seemed brilliant: Roughly $6 trillion in equity was lost by American homeowners between 2006 and 2011, according to Federal Reserve data. Owners in many states have seen declines in values ranging from 20 to 30 percent or more.

Although the national housing market appears to have stabilized and is heading toward recovery, the fact remains that clusters of foreclosures and short sales in many local areas are exerting downward pressure on pricing. There’s still fear of further losses in many neighborhoods — maybe enough to convince lots of people to sign up for some equity protection.

But could the timing for home value insurance have been just a couple of years too late? Agents who signed up to offer policies told me that many consumers and REALTORSR asked them point blank: “Great idea, but why do we need it now, when we can see the market is turning positive? We needed this back in 2006.”

According to insurance agents, the structure of the coverage itself also turned off some potential buyers. Policies came with mandatory deductibles

DOJ Fires Back in Case Against CFPB, Dodd-Frank

By Rob Blackwell

NOV 21, 2012 3:04pm ET

WASHINGTON – A Texas bank’s court challenge claiming that the Consumer Financial Protection Bureau is unconstitutional is wildly speculative and baseless, the Department of Justice said this week.

In a filing with the U.S. District Court for the District of Columbia, Justice said that the $285 million-asset State National Bank of Big Spring and its allies, which include three state attorneys general, lacked legal standing to file a lawsuit against CFPB and the Dodd-Frank law that created it.

The bank filed the lawsuit in June claiming, among other things, that pending CFPB regulations concerning mortgages and remittances had caused it to exit those businesses.

Such allegations are critical because in order to have legal standing, the institution must first establish that it has been harmed.

Yet the Justice Department said State National Bank failed that key test.

“Despite the roving allegations of unconstitutionality set forth in the amended complaint, not one of the statutorily authorized actions that plaintiffs speculate might someday cause them harm has yet occurred,” the Justice Department wrote. “Having failed to allege any actual or imminent injury flowing from the challenged provisions of Dodd-Frank establishing the bureau, or from Richard Cordray’s appointment as director of the Bureau, SNB lacks standing to pursue these claims.”

The lawsuit made waves this summer because it was the first legal challenge to Dodd-Frank. Yet it raised eyebrows as well, with many seeing its chances of success as remote at best.

The bank, joined by conservative groups Competitive Enterprise Institute and the 60 Plus Association, claimed that the CFPB and Cordray’s recess appointment as director in January were unconstitutional. They were later joined by the AGs from Michigan, Oklahoma and South Carolina, giving added importance to the case.

But the Justice Department says all six parties lack any legal standing to challenge Dodd-Frank, saying their arguments of harm are based on what regulators might do, rather than what they’ve actually done.

“Plaintiffs’ claims are unripe,” the Justice Department says. “Future Bureau enforcement actions or regulations, future Council designations, and future orderly liquidation processes that affect plaintiffs are contingent upon subsequent events that may not occur as plaintiffs suggest or may not occur at all. Because the court may never need to resolve these claims, they are not fit for judicial resolution.”

In a statement to American Banker, Sam Kazman, the general counsel for the Competitive Enterprise Institute, said waiting until regulators acted would be too late.

“Constitutional litigation. is not a matter of closing the barn door after the horses have bolted and rampaged the town,” he said. “We believe that the issues raised in this case are ripe, and that plaintiffs are entitled to adjudicate them.”

Among other claims, State National Bank argued in its lawsuit that it was forced to exit the mortgage business in 2010 because it was concerned that the CFPB might crack down on it once it promulgates several required mortgage regulations.

But the Justice Department noted that the CFPB does not have enforcement authority for banks with less than $10 billion of assets.

The bank also argued that it stopped offering remittances after the agency finalized a rule in January requiring more disclosures on such products.

But Justice noted that the bank did not demonstrate that it would even be affected by the rule, which only affects institutions that send more than 100 international remittances annually.

It was equally dismissive of broader claims by the bank that the Financial Stability Oversight Council’s designations of certain nonbank financial firms as systemically important – which have not even happened yet – would somehow benefit such companies.

“SNB’s asserted injury, however, is based on speculation that one of its direct competitors will someday be designated a SIFI (no such designations have occurred), layered upon speculation that this competitor will receive a cost-of-capital advantage from its creditors as a result of the designation (no entities have received such a benefit), layered upon speculation that this cost-of-capital advantage will outweigh the costs associated with heightened federal regulation (not yet finalized),” Justice wrote.

“SNB’s long, attenuated chain of guesswork regarding an imagined course of future events is insufficient to constitute a concrete and imminent injury,” it added.

It also rejected broader claims by the state AGs that their state pensions could one day be hurt in a hypothetical wind-down of a systemically important firm by the Federal Deposit Insurance Corp. Justice noted that no such failure has occurred – or even seems likely to occur – and that the states could not prove their pensions would be harmed.

“None of the plaintiffs has been injured by a Bureau regulation, Bureau enforcement action, Council designation, or Title II liquidation, and their subjective and unfounded fears that they might someday be affected by such actions are not enough to invoke this court’s jurisdiction,” Justice wrote.