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Stalemate on the Hill may spare Fannie and Freddie from reform

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Stepped-up demands from liberal Democrats and conservative Republicans are threatening the prospects for legislation to revive and reform the private mortgage market, six years after it collapsed and largely disappeared during the Great Recession.

As a result, many see an increasing likelihood that Fannie Mae and Freddie Mac, the government-run housing finance giants that required massive bailouts at the height of the financial crisis, but which have served a critical role in keeping the mortgage market up and running since then, may escape the death sentence that political leaders laid down just a few years ago.

While a bipartisan bill has emerged in the Senate to gradually phase out Fannie and Freddie and their dominant roles underwriting and guaranteeing prime mortgages since the government took control of them in 2008, liberal Democrats now want to add mandates that would require private lenders to offer loans to Hispanics, blacks and other disadvantaged groups. If successful, that likely would kill the fragile support for the bill from Republicans, who blame such mandates for causing the 2008 crisis in the first place.

In the House, conservative Republicans are insisting that Fannie and Freddie be entirely eliminated, with no residual role for the government as a last-resort guarantor of mortgage debt as envisioned in the Senate bill. That move likely would spell the end of popular 30-year mortgages and shatter the fragile bipartisan consensus behind the Senate compromise. Because of its divisive approach, House Republican leaders have been reluctant to bring up a bill passed by the House Financial Services Committee that would force the mortgage market to go "cold turkey" without government support.

The Senate Banking Committee this month is expected to mark up the bipartisan bill drafted last month by Chairman Tim Johnson, South Dakota Democrat, and the committee's ranking minority member, Sen. Mike Crapo, Idaho Republican. The bill would phase out Fannie and Freddie while setting up a new agency to offer a much more limited government guarantee on securities backed by prime mortgages.

Banks and private lenders would take over the business of writing and securitizing loans once again, and they would be responsible for covering the first 10 percent of losses on the mortgages they make — providing a big incentive to offer less-risky loans. Banks and borrowers would pay a fee for the government backstop insurance that would cover only losses greater than 10 percent.

The bipartisan measure "moves us closer to ending the five-year status quo and beginning the wind-down of Fannie and Freddie, while protecting taxpayers with strong private capital, building the components for a stable secondary market and avoiding repeating the mistakes of the past," Mr. Crapo said when the bill was unveiled. "Government control of Fannie and Freddie with no private capital to protect taxpayers against losses is unacceptable."

The hope is the bill would entice private lenders back into the mortgage market at a time when some of the biggest players, including Bank of America and J.P. Morgan Chase, are quitting or drastically scaling back their mortgage businesses. Although analysts generally expect the bill to pass through the committee, its prospects are dim. Among other obstacles, Senate Majority Leader Harry Reid, Nevada Democrat, is not keen to bring up the matter with several Senate Democrats facing tough re-election battles, and he is said to be lukewarm about eliminating Fannie and Freddie altogether.

"Odds are against a bill being completed this year" after the bipartisan bill moves out of the Senate committee, said Brian Gardner, a Washington analyst with Keefe, Bruyette & Woods. "We think even a vote on the Senate floor for that bill is less than 50-50."

While both sides seem to agree about phasing out most of what Fannie and Freddie do to package mortgage securities and sell them to investors with an implicit government guarantee, major sticking points have emerged beyond that over the government's role as a last-resort guarantor and promoter of affordable housing, he said.

Keep Fannie alive?

After five years of partisan gridlock on reform legislation, there is a growing fear that reforms may never pass the divided Congress. Beyond the political stalemate, Fannie and Freddie have become increasingly attractive as wards of the government because they are posting sizable quarterly profits that have served to pay back more than their $189 billion government bailouts, while helping slash government budget deficits.

"The most likely way that Fannie and Freddie survive is for Congress to do nothing and totally abandon mortgage finance legislation," said Mr. Gardner. "If this is the outcome, we expect it will be a long, painful death for reform legislation because many in Congress will be unwilling to give up the fight."

Some powerful lobbying forces would quietly prefer the status quo. Legislators increasingly are willing to hold on to Fannie and Freddie as cash cows for the government, and the companies' shareholders who were disenfranchised by the government takeover in 2008 are getting bolder about asserting their rights to share in their good fortunes.

The powerful hedge funds that scooped up Fannie and Freddie shares for pennies on the dollar during the crisis are now demanding that they receive the dividends to which they are entitled, or at least be compensated by the government for taking custody of the companies and seizing their profits without regard to the near total loss for shareholders. Stockholders are also pursuing those arguments in a closely watched court case contesting terms of the government takeover.

The shareholders would be delighted should Fannie and Freddie be kept alive as quasi-government entities whose shareholders enjoy profits in good economic times while the government bears their worst losses in times of crisis.

"Why is there a need to dismantle and destroy, when you can overhaul?" asked David Sims, one of the investors in the distressed equities.

Many homeowners also seem happy with the status quo, which has provided record-low mortgage rates for those with good enough credit ratings to obtain loans since the crisis. Analysts say 30-year fixed rates in the 3 percent to 4 percent range were made possible by the government guarantee of payment to investors provided through Fannie and Freddie and by massive mortgage bond-buying by the Federal Reserve in recent years that drove long-term rates to historic lows.

Rates likely would go higher under the Senate bill, as investors seek to compensate for the increased likelihood that they would sustain losses from defaults, and 30-year rates could double, triple or even disappear under the House bill. Financial analysts say investors likely would be unwilling to offer long-term loans at all to the large swath of subprime American borrowers whose probability of going into default rose as high as 50 percent during the housing crisis.

Among those who are questioning the proposed abolition of Fannie and Freddie is consumer advocate Ralph Nader. In a letter to Mr. Johnson this month, he signaled that some liberals may be willing to join forces with shareholders to keep the enterprises alive.

Mr. Nader argued that Fannie and Freddie are still "functioning and experienced" at keeping the mortgage market running smoothly. Eliminating them would only invite Wall Street investment banks to re-enter the market and repeat the abuses that led to the 2008 crisis, he said.

Liberals, shareholders unite

"To eliminate them and unravel this intricate market further, could open the door wide for runaway corporate exploitation," Mr. Nader said. "We don't argue that the [government-sponsored enterprises] should be maintained as is; but instead that they should be strongly regulated to prevent their previous missteps and abuses."

He added that "shareholders should be allowed to participate in any future recovery."

Raising another concern of liberals, Mr. Nader said the Senate bill — which offers banks incentives to make loans to blacks and Hispanics but does not require them to do so — "does not advance adequate support for affordable and low-income housing for underserved communities." That's a grievance that liberals in Congress and civil rights groups are increasingly voicing in hopes of forcing changes in the legislation.

Home loans have been tough to get for most Americans since the crisis, as banks severely tightened lending standards and caused millions of consumers to go into default and lose their good credit ratings. The dearth of credit has been especially harsh for minority communities hit disproportionately by foreclosures.

Only 131,000 black families obtained mortgages in 2012, compared with nearly 600,000 in 2005 before the crisis, according to the Urban Institute Center for Housing Finance Policy. The share of black borrowers dropped from 8 percent to 4.8 percent over the overall market in that time, and Hispanic borrowers dropped from 13.3 percent of purchases to 8.6 percent. That drove the white share of the market from 65 percent to 71.2 percent.

In the House, conservatives are getting increasingly alarmed about talk of sticking with the status quo or spicing up the legislation with another round of mandates to provide loans to underserved communities.

The House committee bill that would get the government out of the mortgage business altogether, by contrast, has languished for nine months without action in the full House.

Conservative groups have formed a Coalition for Mortgage Security to push for the House bill and fight the Senate legislation. The group is headed by Ken Blackwell, a former mayor of Cincinnati and an undersecretary at the Department of Housing and Urban Development under Jack Kemp. The group aims to "protect taxpayers, investors, and property rights," though by targeting the Senate bill, it also would undermine any hope for compromise legislation that could be signed by President Obama this year.

To keep legislators from getting too comfortable with the status quo, House conservatives have tried a new tack: passing legislation that would force the government to acknowledge its ownership of Fannie and Freddie and include all of their potential liabilities — as well as their current profits — in the federal budget. Under legislation passed by the House this month, the $81 billion in profits Fannie and Freddie are expected to transfer to the Treasury this year to pay down the deficit, for example, would be cut to about $2 billion to reflect future loan losses sustained by the enterprises in times of recession and crisis.

The Treasury's practice of reporting only Fannie and Freddie's profits makes them "appear to be a boon for taxpayers because they reduce the reported federal deficit," while it provides a "free lunch" for legislators trying to avoid serious spending cuts, said Romina Boccia, a budget analyst at The Heritage Foundation.

"This fiscal illusion encourages higher federal spending today while putting taxpayers on the hook for future bailouts" and making it harder to pass legislation to phase out the enterprises, she said.

The accounting change appeals to "good government" advocates who demand an honest accounting of government programs. By exposing the potentially huge hidden liabilities that come with Fannie and Freddie, the change is an "important first step" toward forcing Congress to deal with the unfinished business of housing finance reform, Ms. Boccia said.

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