Mortgage reform leaps a Senate hurdle. Will election politics trip it up?

The Senate banking panel approved, on a bipartisan vote, a bill to redefine the federal role in the housing industry, including how to reshape mortgage giants Fannie Mae and Freddie Mac. Here's how the bill got this far – and why it now may stall.

A bipartisan group of US senators on Thursday did what the American people have been wanting them to do: They tackled a major problem – one left over from the Great Recession of 2008 – and they agreed on a way to solve it. The question now is whether their handiwork can survive the hurricane force winds of election-year politics.

In what is arguably the most significant bill to emerge with the backing of Democrats and Republicans on Capitol Hill this year, the Senate Banking Committee approved, 13 to 9, the gradual demolition and replacement of the two most important mortgage institutions in America – Fannie Mae and Freddie Mac, which guarantee about 90 percent of home mortgages issued today.

The two corporations undergird a housing industry that accounts for about 20 percent of the US economy. In 2008, when the housing bubble burst, Fannie and Freddie almost collapsed and ultimately were propped up by a $190 billion federal bailout. Six years later, they are still under the conservatorship of the US Treasury.

Seven Republicans and six Democrats joined forces to advance the bill out of committee – and straight onto the "to do" list of Sen. Harry Reid (D) of Nevada, the majority leader. The trouble is that Senator Reid has other things on his mind than the mortgage industry – such as how to retain Democratic control of the Senate in an election year when Republicans are threatening a takeover – so he is unlikely to schedule it for a floor vote unless he sees more Democratic support for it.

Reid will weigh “the well being of the mortgage sector of the economy versus the politic imperatives of the political parties of the 2014 election. One is good policy and the other is good politics, and they are not necessarily the same thing,” says Ross Baker, a congressional expert at Rutgers University and the author of the forthcoming book, “Is Bipartisanship Dead?”

The legislation, called the Housing Finance Reform and Taxpayer Protection Act of 2013, would wind down Fannie and Freddie and replace them with the new Federal Mortgage Insurance Corporation. Among its biggest changes, the bill would make the private sector – not the government – the first to bear the risk of bad loans. Fannie and Freddie don’t make loans. They buy mortgages from lenders, and then package them into securities to sell to investors. They also insure mortgages through fees, and pay investors in case the loans go south – which happened in a big way in 2008.

The emergence of this bill from committee represents no small feat. The legislation is baked from scratch – not a warmed-over reauthorization of existing law or some small-bore bill, which is most of what Congress manages in these hyper-partisan times. Anything to do with repairs to the economic crisis is contentious due to the parties' differing views about the role of government. Previous attempts to reform Fannie and Freddie never made it past committee.

The bill was at least 18 months in the works. Instigating Sens. Mark Warner (D) of Virginia and Bob Corker (R) of Tennessee realized from the start that tackling Fannie and Freddie would be “a big lift” and that they needed to build broad support, says Sen. Heidi Heitkamp (D) of North Dakota, an early cosponsor. She attributes the bill’s progress thus far to “two guys … who have impeccable business credentials who are used to solving problems.”

Both men held executive positions in government – Senator Warner as a former governor of Virginia and Senator Corker as a former mayor of Chattanooga, Tenn. Warner made a fortune in telecommunications; Corker, an entrepreneur in the construction business, bought two of the largest real estate companies in Chattanooga.

Their efforts to bring on board senators with differing views began in September 2012, with a working dinner in a side room of the Capitol. On the guest list: three economists who were experts in housing finance, “a rightie, a leftie, and a middle-of-the-roader,” as Corker describes them in an interview. The three developed a “white paper” that, with input from Corker and Warner, served as the basis for further work. “We focused a great deal on the architecture, then we added the plumbing. It’s a very complex topic – the most complex I’ve ever dealt with,” Corker recounts.

As the work progressed, Corker and Warner built concentric circles of support within the banking committee, Senator Heitkamp recalls.

“We came in pairs” – one Democrat and one Republican, she says. “Every time someone came in, they came in with a different set of values and a different idea." Her own top concern, for instance, was that small banks and rural communities not be left out.

“Not everybody got everything that they wanted,” she says. “But as a result, you built not only the product, you built the camaraderie – the fact that we’re now all in this together.”

Think tanks also played a prominent role, as did experts in mortgages, capital markets, real estate, and affordable housing. The lawmakers also looped in key federal agencies and the White House, which welcomed Thursday's committee vote.

Last June, the Corker-Warner bill, S. 1217, was born. In August, staffs from the top lawmakers on the Senate Banking Committee – Chairman Tim Johnson (D) of South Dakota and Sen. Mike Crapo (R) of Idaho – began the big push toward today’s final version. The push would entail no fewer than 10 hearings, plus many late nights, weekends, and pizza boxes for Senate aides.

The central tension to be overcome concerned the role of the federal government. It was resolved through this core compromise: The US government would still guarantee home mortgages, but taxpayers would not be the first line of defense. Private-sector capital would provide a buffer to account for the first 10 percent of potential losses. In today’s market, Corker says, that translates to $500 billion in private capital before any government guarantee kicks in. During the financial crisis, the government spent $190 billion to keep Fannie and Freddie afloat.

Some lawmakers may consider that hit to the private sector to be too big; others may wonder about the need for reform now that Fannie and Freddie are again turning a profit.

In deciding whether to move forward with the bill now, majority leader Reid will examine the committee votes, especially Democratic ones, says Rutgers' Mr. Baker. Senators who represent the liberal base, such as Elizabeth Warren of Massachusetts, oppose the legislation on grounds that it doesn’t do enough to help low-income Americans afford home ownership. Also a consideration: Sen. Jeff Merkley (D) of Oregon, who opposes the bill on similar grounds and is up for reelection this year. “Merkley is a key name here because he’s up,” says Baker. Reid won’t take a bill to the floor that Merkley won’t back.

Negotiations with Democratic hold-outs on the committee continue. Democratic opponents say they're willing to talk, and one possibility is to address their concerns through an amendment. The point is to bring so much backing to the bill that Reid can’t resist its momentum, even in an election year.

But that hill is steep. Failure means the bill would likely become the model for some future effort. 

At Thursday's committee hearing, Corker was upbeat, praising the vote as "a great day" for the Senate. Heitkamp, though, expressed frustration at the slow pace of progress. The Senate, she says, has become too accustomed to accepting “little baby steps as success.”