There’s a lot of legal hubbub in California surrounding Property-Assessed Clean Energy programs. Also known as PACE, the programs could be headed for troubled waters.

PACE programs are financing tools administered by local governments to help real estate owners with green retrofits. For example, homeowners can borrow money to pay for improvements such as solar panels, new windows or insulation. The money is repaid gradually through a special assessment on the property tax bill.

However, the Federal Housing Finance Agency — the regulator of Fannie Mae and Freddie Mac, which together guarantee about half of U.S. mortgages — has expressed concerns over the programs. The regulator and the mortgage lenders warned that, in the case of default, a PACE assessment would have higher priority than mortgages.

In May, Fannie and Freddie issued advice letters to lending institutions suggesting property owners with their mortgages should not be allowed to participate in PACE programs. In July, the FHFA issued a statement saying, “certain energy retrofit lending programs present significant safety and soundness concerns that must be addressed by Fannie Mae, Freddie Mac and the Federal Home Loan Banks.” The agency directed Fannie, Freddie and the Federal Home Loan Bank System to tighten borrower debt-to-income ratios and adjust loan-to-value ratios in any community with programs that even resemble PACE.

Since then, Attorney General Jerry Brown, Sonoma County and the Sierra Club have filed lawsuits against the Federal Housing Finance Agency, Fannie Mae and Freddie Mac. In addition, Congresswoman Doris Matsui sent letters to President Barack Obama and the California Energy Commission urging them to save PACE. Lawmakers, including Matsui, have introduced the PACE Assessment Protection Act of 2010, HR 5766, which would require mortgage lenders to comply with local PACE programs.

“PACE is a safe and sound financing mechanism for energy retrofitting our existing building stock,” says Jenine Windeshausen, Placer County’s treasurer and tax collector. “It is the most promising economic tool for nonexportable job creation, while effectively moving the U.S. toward energy independence.”

The idea for PACE programs came about in Berkeley in 2007. Cisco DeVries was chief of staff to the mayor, and they were working on a variety of energy initiatives. DeVries thought land-secured financing districts, which have existed for 100 years, could be used as a tool to help property owners pay for retrofits to reduce greenhouse gas emissions. “I didn’t invent peanut butter or jelly,” DeVries says. “I just figured out that they make a pretty good sandwich.”

In September 2008 the California Legislature passed Assembly Bill 811, which allowed cities and counties to set up assessment districts so property owners could make energy-efficiency and renewable energy improvements repaid on property tax bills. Later, Assembly Bill 474 expanded the programs’ reach to include water efficiency. The first PACE programs in California surfaced in Berkeley and Palm Desert with many to follow.

The California Energy Commission awarded $16.5 million to CaliforniaFIRST pilot communities in 2010, and Sacramento and Yolo counties jumped aboard. In March Placer launched a countywide PACE program called mPOWER Placer, which was authorized to finance energy and water conservation retrofits for existing structures.

Unlike a loan, a PACE assessment stays with the property rather than the owner. So if a homeowner sells the property before the improvement is paid off, the new owner would be responsible for picking up the higher tax assessment. The seller, therefore, would not bear the full burden of installing a renewable energy system.

“It’s a relatively inexpensive way to finance,” says Beth Mullen, who leads the renewable energy practice at Reznick Group PC in Sacramento. “A city or county can borrow more cheaply than an individual can, and federal stimulus dollars were being used to finance these kinds of programs. Bonds were also used to support them.”

Backers in favor of PACE also tout the environmental benefits: reduced reliance on the grid, fewer “brownouts” and reduced greenhouse gas emissions. “The PACE financing program furthers the Sacramento region’s goal of becoming a leader in the emerging clean energy industry,” Matsui says. “The Sacramento area has received more than $250 million in American Recovery and Reinvestment Act grants for clean energy projects, and Sacramento County received $1.8 million to roll out PACE financing programs in Sacramento. The PACE programs are critical to achieving our energy efficiency goals.”

Matsui also points to a recent report by the Center for Strategic Economic Research. According to the center, the Sacramento Area Voluntary Energy Savings program could create 725 jobs, pumping nearly $30 million in wages into the local economy. The study also estimates the program would generate more than $10 million in state and local taxes including sales, personal and business taxes.

If Sonoma County is any indicator, those Sacramento estimates may not be too far off. The PACE program in Sonoma went live March 2009. Since then, the Sonoma County Energy Independence Program has improved about 1,050 properties, reduced carbon by 1,900 tons, generated three megawatts of new clean energy and created upward of 300 new jobs, according to Rod Dole, the county treasurer and tax collector. “Most of us feel helpless about helping the environment, the economy and new jobs,” he says. “This program offers the property owner help with all three.”

With success stories such as these, local officials statewide were shocked to see the federal regulator’s statement this year. Locally, programs were under way in Placer, Sacramento and Yolo counties. As a result of the regulator’s statement, most of these programs are now on hold. “We have had to suspend our residential program,” says Windeshausen, who adds that Placer County’s mPOWER program was about 85 to 90 percent residential. The county had received more than 100 applications from homeowners for energy retrofitting. “We’re trying to ramp up the nonresidential to keep going.”

Peter Ucovich, a senior planner with Sacramento County’s infrastructure finance section, says the CaliforniaFIRST program is on hold indefinitely. “The CEC canceled the award, so that money is no longer there in light of the FHFA’s opposition,” Ucovich says. It’s unclear when and if funding will be available in the future, he adds.

Yolo County was also planning on participating in CaliforniaFIRST. Hundreds of residents came to meetings about PACE, and there was a high degree of interest in the program. “We were gearing up to launch the PACE program in Davis and other parts of the state and collectively ran into these roadblocks just prior to going live,” says Davis Sustainability Program Manager Mitch Sears. “At this point we are in a holding pattern.”

“I didn’t invent peanut butter or jelly. I just figured out that they make a pretty good sandwich.”

Cisco DeVries, former chief of staff to Berkeley mayor Tom Bates and president, Renewable Funding LLC

Federal stimulus money is contingent on PACE execution. A city or county may have planned to use stimulus dollars, but if the PACE program does not move forward, then the dollars won’t be spent on PACE. Says Mullen, “Stimulus money must be spent in a relatively short time period, so the delay related to the Fannie Mae and Freddie Mac issues could prevent stimulus money from funding a PACE program.”

Despite the statement from the FHFA, some communities are continuing to operate PACE programs. Babylon, N.Y., has refused to shut down its Long Island Green Homes program. Closer to home, Sonoma County suspended SCEIP for about a week after the FHFA, Fannie Mae and Freddie Mac expressed their opposition to PACE programs, but it opted to keep the program running. “The letters mentioned higher restrictions in lending practices, and we wanted to seek support from the community given those threats,” Dole says. “The board decided that it was important to continue creating jobs and saving energy and water. The community was in favor of the program, and the decision was to continue the program while looking for a solution, including litigation and/or legislation.”

In late July, Sonoma filed suit against Fannie Mae, Freddie Mac and the FHFA in federal court. The county’s lawsuit states that energy improvement assessments are exactly like any other local assessment for a public purpose, and that Fannie, Freddie and the FHFA are threatening the rights of state and local governments. “We’re still willing to work with the federal government, but we’re not open to the concept that these are loans and not property assessments within the taxing authority of the state of California,” Dole says.

Attorney General Brown has also filed a lawsuit against the FHFA and the lending giants, arguing that, under California law, PACE is a tax assessment, and Freddie and Fannie are incorrectly describing the programs as loans. Supervising Deputy Attorney General Janill Richards says: “One part of government is saying the programs are safe for homeowners and lenders and serve the public good, and another part of the government is taking back everything. It’s very bad for local governments.” The lawsuit also says that the FHFA failed to conduct the required environmental review of the potential impact of restricting PACE programs.

Others have already filed or are considering legal action. The Sierra Club has filed a lawsuit against the FHFA for blocking PACE, and the town of Babylon has announced that it is preparing a suit against the agency. Placer County, which has incurred approximately $500,000 in administrative and startup costs for the mPOWER program, is considering legal action.

Litigation isn’t the only way that proponents of PACE are trying to save the programs. Congresswoman Matsui was among a group of legislators who recently introduced the PACE Assessment Protection Act of 2010. “The legislation aims to reverse the FHFA decision and restore the PACE program, which is why I have been such a staunch sponsor of the bill,” Matsui says. “It also reaffirms that the PACE financing program is an assessment and not a loan as FHFA calls it.”

In addition, Matsui has sent a letter to President Obama urging him to use his authority to resolve the uncertainty surrounding PACE. “I am also in negotiations with the White House, the acting director of FHFA and a series of high-level appointees at the Treasury Department, the Office of the Comptroller of the Currency and the Federal Reserve on possible ways to restore the program in a timely fashion.” In late August, Matsui sent a letter to Edward DeMarco, the FHFA’s acting director, urging him to resolve the ongoing uncertainty.

Advocates for PACE programs say the FHFA has raised valid points. “The concerns they are raising are legitimate concerns,” Mullen says. She notes that, because PACE is associated with property, it becomes a higher priority than the mortgage.

DeVries says: “We appreciate that mortgage lenders and regulators took an interest in PACE, raised concerns with PACE and wanted to make sure it didn’t increase risk to mortgages. However, those issues were resolved.”

DeVries and other PACE backers say that guidelines and rules were set up that minimized the risk to mortgage lenders. For example, due to the underwriting criteria for PACE, homeowners don’t qualify for the program unless they are current on their mortgage and property tax. Dole says the Sonoma program, which has been operating for 17 months, has had no defaults. In the case of a bank foreclosure, only the delinquent PACE payments, a few hundred dollars, would be repaid ahead of the mortgage, not the full value of the assessment.

PACE advocates say the programs could reduce risk. “Our actions will have no impact on rates of default,” says Kirk Uhler, chairman of the Placer County Board of Supervisors. “In fact, they will make home ownership more affordable.” For example, a tax bill might increase $80 per month, but the monthly energy bill would go down $100, so the homeowner would be $20 ahead.

Under California law, tax assessments can be used to pay for improvements that serve a public purpose. Critics of PACE question whether the programs serve the public good. Richards points out that in passing Assembly Bill 811, the California Legislature expressly determined that PACE serves a public purpose. Ethan Elkind, an environmental law fellow at the UC Berkeley School of Law and the UCLA School of Law, says, “What more of a public benefit is there than reducing pollution and energy use in a community? There’s a huge public benefit for the community and the planet.”

In addition, PACE would help communities by creating green jobs. Mike Anderson, vice president of marketing at Roseville-based Solar Power Inc., says they were ramping up and anticipating hiring construction crews due to a large number of contracts from the mPower Placer program. “A Sacramento program would have meant even more potential jobs,” he says. “It would have had a significant impact on the economy.”

Rick Wylie, president of Beutler Corp., says they were forced to cancel many residential contracts after the mPOWER program was put on hold and customers weren’t able to self-finance. “We hope Fannie and Freddie come to a realization that this is a very positive program,” Wylie says. In the meantime, the company is focusing on the commercial side, which is still eligible for mPOWER financing.

Although advocates for PACE hope the lawsuits or HR 5766 will help save the programs, they are unsure what the future holds. Says DeVries: “Not only were programs running well, but the evidence is that people were saving money and the regulations and rules were working. We can’t lose this momentum. We need to keep moving forward until PACE hopefully comes back.”