Why Senate Democrats Killed GSE Reform

WASHINGTON — Despite a big push to win additional support from Democrats on the Senate Banking Committee, six of the more liberal panel members voted Thursday against a bill to overhaul the mortgage finance system, effectively killing its chances to make it to the chamber floor this year.

The vote was technically a success, with the legislation passing the panel 13 to 9, boosted by the support of six Democrats and seven Republicans. But because it engendered such a split within Democratic ranks, it is highly unlikely Senate leadership will pursue it any further.

While it had become clear during the past week that this was the likely outcome, what was hazy was exactly why top Banking Committee Democrats — including Sens. Jack Reed and Charles Schumer — would vote to undercut their own chairman, Tim Johnson, who co-authored the bill with the panel's top Republican, Sen. Mike Crapo.

Their statements on Thursday helped shed some light on their concerns, although in a few cases they raised even more questions. Below are key takeaways from what lawmakers' said:

Sen. Jack Reed

The most senior Democrat on the panel next to Johnson — and a close ally of the South Dakota Democrat — remained relatively tight-lipped about his objections to the bill at the markup, though he has been a longstanding advocate on affordable housing issues.

"At this moment I'm not prepared to support the legislation. Concern about the 30-year-fixed mortgage — will everybody be able to originate them, will every creditworthy borrower be able to get one? Those are still issues that concern me," he said.

Reed did not cite any specifics of the bill, which would unwind Fannie Mae and Freddie Mac and replace them with a secondary mortgage market backed by an explicit government guarantee.

A spokesman did not respond to requests for any additional comment.

Sen. Charles Schumer

The New York lawmaker has perhaps been the most circumspect of panel members throughout the housing finance reform debate, and he again offered little window into his views at Thursday's vote.

Still, his stance could prove critical to the debate if he takes over as chairman of the committee next year when Johnson retires, making his silence all the more intriguing.

"Members of this committee may differ as to how we believe the housing finance system should look and function going forward over the long term, but I daresay there is not one member that believes that nothing should be done to improve the situation," Schumer said, in addition to thanking lawmakers for their work on the issue.

A spokeswoman did not reply to requests for further comment.

Sen. Robert Menendez

The New Jersey Democrat, another longtime advocate on affordable housing issues, raised concerns about access to credit and rising costs under the proposed system, issues he said need to be explored further before he could support the bill.

"Before we pull the trigger on a major overhaul, we need to be confident that each element will work as intended, and that the system includes sufficient fallbacks in case parts of it do not work as planned," he said in a statement. "We also need a clear understanding of the effects on homeownership costs and access — both the size of the impact and the distribution — as well as financial stability, economic growth, and taxpayer protection."

Menendez said that he remains particularly worried about access to credit for first-time homebuyers, particularly minority and lower income borrowers across the country.

"It is critical that the system does not needlessly exclude first-time homebuyers—like I once was—who do not come from historically 'favored' backgrounds and who may not be purchasing a home in historically 'favored' communities, but can afford to buy a home and responsibly pay their mortgage," he said.

He added that work on the issue should continue, including more piecemeal efforts.

"I think it would be productive to continue developing ideas that have been discussed and, where appropriate, establish pilot programs or move them by legislation, whether as a single package or in separate pieces," he said.

Sen. Sherrod Brown

Brown is also a leading contender to take over as leader of the banking panel next year, and so his remarks are critical for helping to understand what kind of approach he could take next year. Still, many observers have questioned whether he would take up housing finance reform at all as a major focus.

The Ohio Democrat elaborated Thursday on earlier concerns he's raised with the legislation, taking issue with a number of different aspects of the framework.

"Simpler reform is better reform. I am concerned that the complexity of the legislation before us could: create opportunities for arbitrage; distort pricing; increase concentration; and exacerbate systemic risk," Brown said in detailed written remarks submitted for the record. "This framework creates unrealistic expectations that regulators will be able to protect borrowers and taxpayers, and further distorts an already unlevel playing field for our community institutions."

Critically, he warns that the new system "will be motivated by the same combination of private profit and public guarantee as the enterprises" and puts too much power in the hands of big banks.

He also takes issue with how market players would meet a 10% first-loss capital requirement in the legislation, warning that "the definition of 'capital' in the bill is too weak, that regulators can waive capital requirements during crisis, and that regulators can still bail out companies that are too important to the mortgage financing market."

The concern about capital was also shared by several lawmakers on the other side of the aisle, including Sen. Richard Shelby, R-Ala., who could take control of the committee next year if the GOP wins the Senate.

"While many in the industry have expressed concerns over 10% being too high, I am concerned that this bill does not require real capital in the first place," Shelby said at the markup. "Would the type of capital permitted under this legislation meet Basel standards, which I would argue are still not strong enough? Would the capital be truly risk-absorbing in the event of an adverse event? In my view, capital in the 'first loss' position should be no riskier than a Treasury security."

But Brown's comments were hardly in full alignment with his Republican colleagues, particularly as he raised questions about the need to get rid of controversial affordable housing goals like those in place at the GSEs for decades.

"I am also not convinced that it is time to do away with the enterprises' affordable housing goals and duty to serve," he said. "Eliminating the goals and the duty appears to be based more in ideology than anything else, and the burden rests with those who want to replace them to show that the new system with serve all communities better — including rural and minority borrowers."

He also urged the need for reforms to the private-label security market, including creating a fiduciary duty for servicers and trustees.

"Private capital simply will not come off the sidelines without such protections, and our efforts will be incomplete without them," he said.

Sen. Jeff Merkley

The Oregon lawmaker did not delve into great detail over his concerns with the bill, but reiterated worries about access to credit for traditionally underserved markets and the impact of the legislation on the middle class.

He also raised broader questions about the framework of the bill, and the need to prevent another major crisis.

"The heart of it is, we should wrestle with this — do we have a regulatory system that can keep the for-profit motives from repeating the extensive risky investments for short-term gain that could result in another blow-up down the road?" Merkley said.

Sen. Elizabeth Warren

The Massachusetts Democrat has been more vocal on the issue of housing finance reform than some of her colleagues who ultimately voted against the bill, and elaborated on some of her ongoing concerns Thursday about affordability and access to the housing system and the role big banks would play in the market.

Warren argued that the legislation would further reduce access to a government-backed mortgage by 20% compared with the current system, and raised concerns about market access for families in inner cities and rural communities. She also criticized the bill's plan to replace affordable housing goals with a user fee that incentivizes lending to traditionally underserved markets.

"Current law imposes a duty on Fannie and Freddie to make sure that these markets are served, which has put homeownership in reach for millions of families in urban and rural neighborhoods," she said. "This bill would replace that duty with a new incentive fee. While the incentive fee approach holds out some promise, it is untested and unproven, and it needs to be backed up with real penalties to ensure that the market serves all creditworthy borrowers, regardless of where they live."

She added that the bill doesn't provide enough protections to smaller banks to compete on a level playing field with the largest institutions.

"Current law gives giant banks and small banks comparable access to Fannie and Freddie. But this bill would give the mega-banks a significant leg up over their smaller competitors," she said. "That could drive smaller lenders from the market — reducing access to mortgages for the urban and rural communities those smaller lenders serve, and allowing the 'too big to fail' banks to grow bigger still."