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Elizabeth Warren Splits Progressives On Mortgage Reform

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Sen. Elizabeth Warren, of Massachusetts, at a rally in support of Kentucky democratic candidate Alison Lundergan Grimes, June 29, 2014. Warren is leading talks on Fannie Mae and Freddie Mac. (AP Photo/Timothy D. Easley)
Sen. Elizabeth Warren, of Massachusetts, at a rally in support of Kentucky democratic candidate Alison Lundergan Grimes, June 29, 2014. Warren is leading talks on Fannie Mae and Freddie Mac. (AP Photo/Timothy D. Easley)

WASHINGTON -- Sen. Elizabeth Warren (D-Mass.) is dividing Wall Street critics in Congress by leading talks regarding a controversial Fannie Mae and Freddie Mac reform bill that some of her usual allies would prefer to abandon.

Warren is negotiating with Sens. Bob Corker (R-Tenn.) and Mark Warner (D-Va.) over a housing finance overhaul that cleared the Senate Banking Committee in May. The bipartisan bill, authored by outgoing Senate Banking Committee Chairman Tim Johnson (D-S.D.) and Sen. Mike Crapo (R-Idaho), has been sharply criticized by bank reform advocates, including Warren, and some conservative groups for recreating many of the same problematic incentives that took down Fannie and Freddie in 2008.

The dispute among Democrats on the banking committee is mostly over tactical considerations, but it has unearthed an ideological fault line in the progressive movement: Should Fannie and Freddie be reformed to be more friendly to the middle class, or should their operations be scrapped in favor of a private -- or fully public -- system?

"The whole Crapo-Johnson approach ... seeks to replace a mortgage system the size of JPMorgan Chase and Citigroup combined [and] is a dangerous and misguided approach that creates unprecedented complexity in the form of an experiment that may not work -- and at worst, will roil and unsettle markets and risk our system of mortgage finance," said Josh Rosner, managing director at Graham Fisher & Co. "It is worse than GSEs were at their worst."

Sen. Robert Menendez (D-N.J.) is also involved in the talks, but it's Warren's seal of approval that has some progressive housing advocates fretting. According to multiple Democratic sources, Sen. Sherrod Brown (D-Ohio), one of the most forceful Wall Street watchdogs in Congress, would prefer to see the bill scuttled entirely. Sen. Jeff Merkley (D-Ore.), arguably Warren's closest Senate ally, is sitting out the negotiations. And Sen. Chuck Schumer (D-N.Y.), who consistently votes with Warren on the committee and is emerging as a surprisingly reliable skeptic of big banks, has also avoided the talks. Six Democrats on the committee voted for the original reform bill, which Warren voted against. Negotiators need to secure at least three additional votes to convince Senate Majority Leader Harry Reid (D-Nev.) to bring the bill to the floor.

Warren's progressive opponents argue that her chief goals are at odds with one another, and a significant strategic risk is attached to having her name on a bill that could change dramatically either on the Senate floor or in the House. Supporters argue that she is targeting core problems with the bill, and believe a bipartisan Senate consensus would make it easier (eventually) to enact a good bill.

"This is a long game," said Barry Zigas, a former Fannie Mae senior vice president who now serves as director of housing policy for the Consumer Federation of America. "The economy needs a fair and durable mortgage finance system, and the Johnson-Crapo bill solidified bipartisan support for critical parts of that, including a federal guarantee for mortgage securities. But it needs more work, and Sen. Warren's, Sen. Corker's and others' efforts on both sides to improve it -- especially to make sure it serves the broadest possible range of creditworthy borrowers and holds its participants accountable for doing so -- are really important."

Fannie and Freddie exist, ostensibly, to lower the price of mortgages for consumers. The firms purchase mortgages from banks, pool them into securities, and sell them to investors, while guaranteeing those investors against losses. That guarantee increases investor appetite, which allows banks to offer mortgages at lower interest rates.

Prior to the crash, that system hinged on an implicit government guarantee: Investors knew that if anything ever happened to Fannie and Freddie, taxpayers would take the hit. But this support encouraged Fannie and Freddie -- which officially functioned as for-profit companies -- to engage in increasingly risky activities in the pursuit of higher payouts for shareholders and executives. When Wall Street banks started scoring huge profits on subprime loans, Fannie and Freddie followed their lead and, like the big banks, were ravaged and bailed out.

In an era of congressional stalemate, the mortgage finance status quo has its advantages. Liberal economist Dean Baker has emphasized that government control of Fannie and Freddie eliminates the core problem of the old order: private profit at public expense. The government is currently on the hook for losses, but it also books the profits from Fannie and Freddie's dealings.

There are also problems. Then-Treasury Secretary Timothy Geithner set up a bailout repayment plan for Fannie and Freddie that makes it impossible for the firms to establish a capital cushion. The profits from their current operations are simply swept back into Treasury every quarter. Without beefier capital levels, Fannie and Freddie are barred from changing mortgage standards that would allow many creditworthy middle-class families to buy homes.

"Sen. Warren opposed the Johnson-Crapo bill in committee because she believes that it would make it harder for creditworthy borrowers to get affordable mortgages and for smaller lenders to compete against larger ones," Warren spokeswoman Lacey Rose told HuffPost. "But she is also very concerned about the lack of access to mortgage credit in the current system for lower income families and African-American and Hispanic families."

U.S. homeownership rates have long been sharply stratified by race, a phenomenon Suzy Khimm recently detailed for MSNBC. Even in the heyday of the housing bubble, most African Americans did not own a home. Today, the figure is about 43 percent, compared to 72 percent for whites. While lending standards for Fannie and Freddie have tightened already, a botched overhaul could easily leave much of the market, particularly people of color, without good options.

The current alternatives to Fannie and Freddie are, at the high-end, the jumbo mortgage market, and at the other, the Federal Housing Administration. The jumbo market is for loans that are too big to qualify for Fannie and Freddie treatment, and features higher interest rates since its loans don't benefit from government backing. The government runs FHA to assist first-time borrowers seeking smaller-sized loans, and conservatives have long waged an ideological campaign against the agency's very existence, as affordable housing advocates are well aware.

"We don't want a housing apartheid, where you've got one system over here for the better heeled homeowners and then everything else is dumped in an FHA bucket," said Urban League President and CEO Marc Morial.

Warren has focused on two central aspects of Johnson-Crapo. First, the bill's weak language on affordable housing provides no homeownership mandate, and no requirements to make loans in underserved markets. Second, its potential to exacerbate "too big to fail" by turning over many of Fannie and Freddie's powers to Wall Street, replete with government subsidies. Tackling either issue is a tall political order, and in some ways, the two goals are in conflict.

Johnson-Crapo offers two replacement regimes for Fannie and Freddie. One would allow Wall Street banks to sell mortgage bonds that put private-sector investors on the hook for 10 percent of all losses, with the government shouldering the remainder. It's easy to understand why banks have been lobbying hard in favor of such an arrangement. It would give them a piece of Fannie and Freddie's game, allowing them to offer "low-risk, high reward" products -- a financial holy grail that doesn't currently exist on the private market. It's also the same public-risk-for-private-profit model that brought down Fannie and Freddie, and a big new line of business for banks that are already too big to fail.

Warren wants to forgo that model in favor of the other system outlined in Johnson-Crapo, which would require a public utility to issue mortgage bonds, with 100 percent of any losses insured by a heavily regulated private company. The government would only step in should the insurer fail.

Every bank reform Democrat on the banking committee agrees that Warren's "bond guarantor" model is an improvement. But the model has credible detractors, including Rosner, a longtime critic of Fannie and Freddie who was one of the few to accurately diagnose the problems that eventually brought them down.

"This is the worst Rube Goldberg approach: Rather than fixing the GSEs as fully private, well-capitalized entities with real capital and rate-of-return caps and no guarantee, which would lead market participants to price deals based on the GSEs' capital, deals will be based on a government backstop," Rosner said. "It's a horrible subsidy that ensures a future systemic event."

By focusing on the types of public-private hybrids that might be acceptable, the ideological scope of the housing reform talks has narrowed significantly since the years immediately following the crisis. Rosner and other reformers, including Raj Date, an ally of Warren's at the Consumer Financial Protection Bureau during the agency's formative years, had advocated doing away with the convoluted subsidies of the Fannie and Freddie system in favor of a private market with more straightforward tax credits. Rosner advocates a special tax program to help low-income families save for a down payment. He has also argued that the mortgage interest deduction, which rewards families for taking on debt, should be swapped out for a mortgage equity deduction, which rewards families for paying it down.

Such an approach to housing subsidies would be far more efficient than anything currently being contemplated by the banking committee. And its efficiency is one reason why it has little political support. Conservatives are reluctant to vote for a direct subsidy, even one that would ultimately save taxpayers money. And elected officials consider any move away from the very popular mortgage interest deduction to be politically toxic.

The basic, legitimate social goal of giving citizens access to an affordable house and financial foundation is also a convoluted game of insider rewards: Any piece of mortgage-related legislation typically has to benefit various interest groups -- from realtors all the way up to hedge funds -- in order to actually pass Congress.

To advance the "bond guarantor" model, Warren will have to work out tricky technical details. Capital is the buffer between the bond insurer and taxpayers, and that buffer needs to be robust to protect the latter. But among Democrats, progressive and otherwise, there are real differences on the subject.

Warren subscribes to a widely held belief in high finance that hefty capital standards make loans more expensive, although some recent research on capital has concluded that this idea is simply wrong. But Warren, with backing from some affordable housing nonprofit groups, is pushing to reduce capital levels in the name of cheaper mortgages.

When they were taken over, Fannie and Freddie backed about $5.5 trillion worth of mortgages, and they burned through $78 billion of their own capital and more than $187 billion in taxpayer funds -- combined capital a bit less than 4.9 percent of the total mortgage book. Johnson-Crapo requires each regulated bond insurer to take on a 10 percent threshold, although it doesn't define what would count as capital (some kinds of debt are often permitted). Warren wants to bring that number down, and accompany it with a serious affordable housing mandate to prevent the new system from locking out creditworthy borrowers of modest means.

If one believes that deeper capital reserves make things more expensive, then one must strike a balance between protecting taxpayers with capital buffers and serving the market with affordable mortgages.

And then there are the very real political considerations. Even if Warren could cut a deal that included affordable housing standards and eliminated the most noxious of the public-private partnerships, she would still need to protect the core reforms on the Senate floor. The House, meanwhile, is pushing a bill that would simply eliminate Fannie Mae and Freddie Mac, and let the market do what it will. Reconciling the two bills would be difficult, and given the political gulf between the chambers, the possibility of reaching such an agreement in 2014 borders on fantasy. If Democrats hold on to the Senate in the November elections, Brown is likely to serve as the next chairman of the banking committee, giving a Wall Street watchdog and Warren ally more leverage over a bill to chart the future of Fannie and Freddie.

On the other hand, if Republicans take the Senate, any deal Democrats could get becomes that much less favorable to the party's core constituents. Then there's always the status quo.

"I think it's a good idea to try and move the ball," said the Urban League's Morial, "but a deal that doesn't create a system that's better than the current system is not one that we can support."

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