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Real Estate and the Recovery

A Senate Battle Over Mortgage Rules

Lenders are slowly thawing as the financial crisis recedes, but many families with imperfect credit still find it hard to get approved for a mortgage. And just as winter fades to spring, the thaw leads to calls for Congress to do more to foster affordable mortgages.

The problem is that loosening lending standards poses the risk of creating bad loans like those that were at the root of the crisis. Taxpayers are on the hook to cover the costs of future housing-related problems, since the vast majority of new mortgages are backed by Fannie Mae and Freddie Mac, which have been in government control since September 2008.

The difficulty of finding an acceptable balance between expanded lending and taxpayer protection was behind the breakdown of efforts to overhaul the American housing finance system. A group of six Democratic senators walked away from negotiations on the Johnson-Crapo housing finance reform bill out of concerns that it would not do enough to ensure broad access to mortgage financing. While no senators wanted the government to back the subprime and Alt-A loans that featured so prominently in the prelude to the financial crisis, there was less consensus on what should happen to borrowers with some blemishes on their credit history or those who could provide only a modest down payment of 5 percent or below of the price of their home.

The left-leaning senators Sherrod Brown of Ohio, Robert Menendez of New Jersey, Jeff Merkley of Oregon and Elizabeth Warren of Massachusetts sought for such potential homeowners to be included in the government guarantee created in the new system. In the parlance of housing finance, the Democratic senators wanted a large credit box — a relatively expansive view of the role of government in supporting housing.

Those senators objected to the provision in the Johnson-Crapo proposal to have eligibility for the government guarantee roughly follow guidelines set out by the Consumer Financial Protection Bureau to ensure that borrowers have the ability to repay their loans — an irony in that the left more typically defends the bureau against criticism. (Jack Reed of Rhode Island and Charles Schumer of New York, both more usually viewed as centrists on economic issues, joined the coalition against the bill).

Consumer groups allied with Mr. Brown and the other left-leaning senators took issue with a requirement that potential homeowners make even modest down payments to qualify for government-backed loans — as little as 3.5 percent in the Johnson-Crapo proposal for first-time home buyers. Housing advocates were essentially advocating for no-money-down mortgages, on the theory that scrutiny of individual borrowers and other requirements such as mandatory financial education can provide confidence for taxpayers to stand behind otherwise risky mortgages. This upends the usual belief that a meaningful equity stake in one’s own home is an essential motivation to pay the mortgage.

Even if the bill had allowed an expansive standard for mortgages to qualify for the government guarantee, risky borrowers — those at the “edge of the credit box” — would still need to find a bank willing to make them a loan. This would be no trivial matter, since each of those mortgages would need private investors willing to put a considerable amount of their own money at risk to cover losses before the government guarantee kicked in.

The six Democratic senators also wanted to ensure that banks and other mortgage originators didn’t make loans only to people with pristine credit histories. Under the “duty to serve,” sought by the Democrats, firms involved in mortgage loans would have an obligation to ensure that mortgages are available to “all eligible customers” including by reaching out to “traditionally underserved” communities.

Republicans noted that all firms would be subject to anti-discrimination laws, but saw the loose lending standard and duty to serve obligation as both inappropriate interference in business decisions and too far a step back toward the problems that led to the crisis. The policy discussion over housing finance can thus be seen as echoing a larger debate over the role of government — in this case, regarding the extent to which taxpayers should take on risk to support homeownership.

The Johnson-Crapo bill was approved by the Senate Banking Committee with a bipartisan 13-to-9 vote on Thursday. Despite the endorsement of the legislation by President Obama, the majority leader, Harry Reid, Democrat of Nevada, is not likely to allow further action in the Senate, given the opposition in his own caucus.

In the absence of legislative progress, Melvin Watt, the director of the Federal Housing Finance Agency, announced on Tuesday that he was instructing Fannie and Freddie to expand their support for the housing market, while postponing increases in the fees collected by the firms to compensate for the associated risk.

With reform stalled, the housing finance system is thus once again turning back toward a greater role for the government and risk for taxpayers.

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