Monterey County was poised for a rooftop Renaissance. Then Fannie and Freddie crashed the party.

An article on the county building department’s bulletin board is a source of both pride and pain for Tim McCormick and Karen Riley-Olms.

The headline reads: “State attorney general sues feds over solar financing” – the very same Property Assessed Clean Energy (PACE) program that McCormick, the county director of building services, and Riley-Olms, the county’s PACE project manager, have been working on for more than a year.

Pain, because right at the launch of a much-buzzed-about program to fund solar panels and energy efficiency upgrades on middle-class homes across California – Scientific American named the PACE financing model one of the top 20 ideas that can change the world, and Harvard Business Review put it in the top 10 breakthroughs of 2010 – mortgage giants Freddie Mac and Fannie Mae, with the blessing of their federal regulator, killed it.

Now Monterey County’s planned September PACE launch “has been postponed indefinitely,” Riley-Olms says.

“We were just waiting for the money to roll out, literally within weeks,” McCormick adds. “Now the funds are frozen. It’s like you just ran a whole horserace, you’re in the last 100 yards from the finishing line, and someone threw a roadblock in.”

Pride, because California is fighting back. The feds have already gotten an earful from Gov. Arnold Schwarzenegger, a swarm of state and federal legislators, local officials and business councils. Two weeks ago, Attorney General Jerry Brown – who, in convenient timing, is ramping up his November run for governor – slapped a lawsuit on America’s hulking mortgage siblings and the Federal Housing Finance Agency.

“That’s what we need our attorney general to do,” McCormick says.

Environmentally and economically speaking, PACE was supposed to be awesome.

The clean energy financing model is designed to cut greenhouse gas emissions, create green jobs and lower household utility bills at virtually no up-front cost to property owners. If it were applied to 15 percent of U.S. homes, a 2009 UC Berkeley study found, PACE could finance more than $280 billion in energy retrofits and cut a gigaton of greenhouse gas emissions.

It’s often described as a low-interest local government loan, backed by bonds. The money can be used for renewable energy, water conservation or energy efficiency upgrades. The property owner pays it back over 20 years or less in annual installments – ideally close to the property’s annual utility savings – that show up as a line item on the property tax bill. If the home sells, the new owner takes over the payments.

But California officials don’t like the word “loan,” in a technical sense. They consider PACE a special assessment: a property tax add-on that supports a project that benefits the community. Local governments routinely issue special assessments for things like road improvements and sewers. But PACE assessments would only apply to properties with government-sponsored energy retrofits.

Here’s the part Fannie and Freddie don’t like: If a property forecloses, its unpaid PACE bill becomes a “first lien.” The county gets paid its outstanding property taxes, including PACE assessments, before the mortgage lender can claim the rest.

That lien detail makes PACE loans a lower-risk proposition for investors, leading to lower interest rates on the bonds. But it’s an added risk for mortgage lenders, who eat the loss when a PACE property goes underwater.

County Supervisor Jane Parker would like to put solar panels on her new home in Marina. But she says she and her partner, local labor leader Chris Fitz, were hoping for PACE’s help in making it happen.

“We really don’t have the money in the bank to be able to do it with the upfront costs,” she says. They could try to put an array together one panel at a time, but Parker’s holding out for a system that could offset most of her household energy use – including, perhaps, a charging station for the electric vehicle she’d one day like to drive.

“If you are wealthy, you can make the purchase of solar panels yourself. But for regular people, an investment of $30,000 or $40,000 to have a full solar array is really out of reach,” she says. “This program is designed to help businesses and residents who don’t have flush bank accounts participate in promoting the use of renewable energy.”

Parker made environmental initiatives one of her two top priorities upon taking office in 2009. She says she found an ally in Supervisor Simón Salinas, who shares her interest in alternative energy, and the two supes began rallying the county to explore PACE financing.

The legislative stars were aligned in their favor. In 2006, California adopted a mandate to lower greenhouse gas emissions 25 percent by 2020. (That bill, AB32, is up for repeal on the November statewide ballot). Two years later lawmakers approved AB811, which helps the state meet its AB32 emissions target by authorizing local governments to issue PACE assessments.

The Competitive Clusters program of the Monterey County Business Council saw the economic potential in AB811, and in February 2009 hosted a meeting on PACE financing. A month later, the supes directed county staff to look it.

“We were just waiting for the money to roll out, literally within weeks. Now the funds are frozen.”

McCormick and Riley-Olms studied the models, evaluated the legal and financial risks, gauged the market interest and compared PACE programs in other jurisdictions (see sidebar, p.X).

They hit an early hurdle with the enormous start-up costs. Then, like a fairy godmother, the federal Department of Energy awarded the California Energy Commission’s State Energy Program $226 million for energy efficiency and renewable energy projects.

It looked like a good year for sunshine.

Jason Burnett, founder of Marina-based financing consultant Burnett EcoEnergy, was inspired by the PACE idea. He knew it made the most economic sense on a large scale, so he worked with the county’s new Alternative Energy and Environment Committee – Parker and Salinas are both members – to win supportive resolutions from each of Monterey County’s 12 cities, along with the county itself.

But even a united Monterey County seemed too small for PACE. “For the program to be sustainable and self-supporting, we will need to get a low enough interest rate – about the same, if not less, than what people can get if they go to a bank for a home equity loan – that people will be interested,” Burnett says.

Santa Cruz was already a few steps ahead. So Burnett reached out to Ecology Action, Santa Cruz County’s nonprofit PACE consultant, and the neighboring counties teamed up.

San Benito County quickly tagged on, and soon the coalition grew to include 14 California counties and more than 120 cities: big enough, they hoped, to attract grants and low-interest bonds.

“It sort of went viral,” Ecology Action Program Manager Colin Clark says.

Then came the task of securing those bonds. The coalition turned to the California Statewide Communities Development Authority, a joint powers agency that helps local governments with low-cost financing for public interest projects. California Communities took on the coalition’s PACE mission and called it CaliforniaFIRST.

More than a solar financing program, CalforniaFIRST aims to fund all sorts of energy and water efficiency retrofits, such as air sealing, double-paned windows, wall and roof insulation, tankless water heaters and low-flow toilets. Financing can be for up to 10 percent of the property value.

Earlier this year, the California Energy Commission awarded CaliforniaFIRST $16.5 million to cover start-up costs: marketing, administration and bond interest buy-down. Just that pilot stage is estimated to save almost 75 million kilowatt-hours of energy, create about 2,000 jobs and jump-start $450 million in energy retrofit projects.

CaliforniaFIRST doesn’t have a bond interest rate locked down yet, but proponents are hoping for less than 7 percent. “Nobody’s really flipped one of these bonds before,” Clark says.

But with 21 other states looking at PACE programs, he adds, “it would eventually be quite a big and lucrative bond market.”

Last October Vice President Joe Biden announced the federal “Recovery Through Retrofit” initiative, focused on creating green jobs while reducing greenhouse gas emissions through home energy efficiency upgrades. The report specifically highlighted PACE as the sort of program that would be rewarded with federal stimulus dollars.

The federal Department of Energy and Department of Housing and Urban Development followed through, awarding a half-billion dollars in stimulus funds for energy efficiency and conservation programs to California local governments and the CEC’s State Energy Program. About $30 million of that was earmarked for PACE-specific programs. The money helped leverage another $370 million in potential state, private and federal incentive funds.

But in early May, Fannie and Freddie – which together guarantee more than half the nation’s residential mortgages – issued advice letters to mortgage lenders, stating that PACE assessments shouldn’t take first lien priority over standard mortgages.

“They’ve scared the mortgage companies and all the banks that would be selling conforming mortgages,” Burnett says. “In the places where this program was fully operating, like Sonoma County, it’s had a chilling effect.”

California Attorney General Jerry Brown wasn’t having it. He wrote two letters to FHFA Acting Director Edward DeMarco in May and June, pressing the agency to hush its conservatees up. Too much money and too many jobs are at stake, he wrote: If Fannie and Freddie don’t stop picking on PACE, the state might be forced to sue.

The FHFA took Brown’s challenge, and on July 6 suspended PACE programs across the nation. It added an olive branch: PACE assessments already in effect should be honored. Brown, as promised, sued Fannie, Freddie and the FHFA on July 14.

FHFA zapped back a same-day retort, pledging to “defend vigorously its actions that aim to protect taxpayers, lenders, Fannie Mae and Freddie Mac. Homeowners should not be placed at risk by programs that alter lien priorities and fail to operate with sound underwriting guidelines and consumer protections. Mortgage holders should not be forced to absorb new credit risks after they have already purchased or guaranteed a mortgage.”

It was a ballsy statement coming from such a new acronym. Created by merging several other federal agencies after the 2008 housing crash, FHFA has been named Fannie and Freddie’s conservator.

You’re forgiven if that makes you think of the fallout from Britney Spears’ head-shaving, SUV-bashing episode, when a judge gave her dad control of her finances. The court-ordered conservatorship of Fannie and Freddie after the subprime mortgage crisis is essentially the same thing, except that these “toxic twins,” to use The Wall Street Journal’s phrase, have blazed through about $145 billion in taxpayer dollars, with more losses coming.

That heavy task – to prevent another housing crash – may explain why FHFA is so skittish about PACE. It’s an added risk at the housing market’s most vulnerable moment.

“We were really hoping the Obama administration would fix this. They did not.”

Yet foreclosed properties with PACE assessments would probably only deprive banks of a few thousand dollars each. To use Brown’s example: A home with a $250,000 mortgage and $15,000 in PACE financing, at 7 percent interest over 20 years, would have an annual PACE assessment of $1,470. If that home goes into foreclosure, the lender eats that $1,470 – not the whole $15,000. The next property owner would then take over the annual PACE payments for the rest of the payoff term.

Even if it has taxpayers’ interests at heart, the FHFA’s position on PACE might not earn it Brownie points with a public that still feels cheated by the mortgage industry.

Since its debut in September 2008, Fannie and Freddie’s new regulator has kept a low public profile. Now it’s making news for helping Fannie and Freddie kill a program meant to give middle-class homeowners a break – and for contradicting a White House administration that has dedicated hefty stimulus funds specifically to make programs like PACE possible. To many observers, FHFA’s eleventh-hour PACE prohibition essentially snuffs out a market tool for reducing greenhouse gas emissions, gaining energy independence, and making robust green jobs bloom from, literally, sunlight.

“They’re not coming out of the gate too clean on this one,” McCormick says. “It just seems like a total disconnect to have the president pushing these news ideas and a new federal agency putting the brakes on it.”

Fannie Mae did not respond to the Weekly’s inquiries; Freddie Mac referred all questions to the FHFA. Agency spokeswoman Stefanie Mullin says the FHFA has no comment beyond its two published statements.

Attorney General Brown alleges that Fannie-Freddie-FHFA’s PACE smackdown “misrepresents California law” and “essentially forecloses residential PACE programs,” putting federal stimulus money at risk and harming the environment without proper review, in violation of the National Environmental Policy Act.

His lawsuit asks the federal court in San Francisco to confirm that PACE assessments are valid under California law, may result in first-priority liens, and are compatible with standard mortgages. It seeks an injunction to stop Fannie and Freddie from taking action against mortgage holders who participate in PACE programs, and asks FHFA to conduct an environmental review under NEPA before trying to mess with PACE.

A central legal question is whether PACE constitutes a loan or a tax assessment for public benefit. California’s AB811 clearly considers it the latter.

“Fannie Mae and Freddie Mac are ignoring that and declaring just the opposite,” says Julia Levin, special assistant to Brown. “We were really hoping the Obama administration would fix this. They did not. We filed the lawsuit as a last resort.”

Levin hopes Congress will solve the glitch quickly rather than waiting for the suit to slog through the courts. On July 15, U.S. Rep. Mike Thompson (D-S.F. Bay Area) and 29 other legislators introduced a bill to undo the FHFA decision and allow PACE to move forward.

If the issue isn’t solved quickly, Levin adds, PACE programs could lose hundreds of millions of federal stimulus dollars. Some of those funds must be “encumbered” by the end of September. If the PACE freeze lasts for more than a few weeks, she says, local governments will have to shift the money into other energy programs in order to keep it.

“[Programs like PACE] are creating jobs right away, they’re saving consumers money at a time when we all need that, and they are attracting new businesses and technologies to California,” Levin says.

The PACE crusade probably doesn’t hurt Brown’s campaign for governor, either.

“This is an action he’s taken as attorney general, not because he’s a candidate,” Levin counters. “But clean energy development and clean jobs is a very important priority for him as a candidate for governor.”

Monterey County Business Council President Mary Ann Leffel bets the feds will find a way to remove the PACE roadblock. “It’s the right thing to do for the homeowner and the community,” she says. “I imagine this will get worked out in the next 90 days.”

The council has written letters to local Congressman Sam Farr and Senators Barbara Boxer and Dianne Feinstein, entreating them for a quick resolution to the PACE roadblock.

Meanwhile, Leffel’s pushing for a county ordinance – drafted by a group of local fire marshals, contractors, realtors and solar installers – that would permit larger solar arrays on residential roofs in preparation for a flood of local PACE projects.

As someone who’s had 45 years’ experience in banking, Leffel says she understands the mortgage industry’s concerns about PACE’s priority lien status. But she thinks a few safeguards could minimize the risk: Check the property owner’s credit score, and ensure there are no other liens on the first mortgage.

“From a lending standpoint, we are not talking about massive amounts of money,” she says. “We’re talking about something that makes the house more valuable and more affordable to the consumer.”

In the bigger picture, she says, PACE clearly works in the public interest. “It’s a job creator. I’d rather someone be paid for this than collect another 20 months of unemployment,” she says.

The county is also making its voice heard. On July 27, the county Board of Supervisors resolved to support Rep. Thompson’s PACE bill, press Congress on local governments’ right to establish clean energy programs, and ask the CEC for continued financial support of CaliforniaFIRST.

Even without PACE, county officials hope to incentivize local energy retrofits.

“We’re looking at other ways to do the financing,” Riley-Olms says, sounding a little deflated. “It would not be the same type of program at all, but there are other alternatives for financing energy efficiency projects.”

“At the end of the day I think these programs make too much sense to die out,” McCormick adds. “We just have to get our elected officials involved. Frankly, it’s an economic development issue as well. The demand’s there, even in this economy, because people know it’s gonna save them money. This is a time we need this work.”