DEFENSE OF THE AMERICAN HOME

Wednesday, March 25, 2009

Mr. Merkley:

Mr. President, I rise today to call on my colleagues, and indeed upon all Americans, to rally to the defense of the American home.

Sometime soon, within the next few weeks, this esteemed Chamber will be taking up this issue. So this seems to be an appropriate time to reflect on how to improve our policies for promoting homeownership.

There is nothing that characterizes the American dream better than owning your own home. The homeowner is the king–or queen–of his or her castle. You decorate and remodel it to suit your own taste and style. You are your own landlord; no one can tell you what you can or can’t do. You fence the yard so you can finally have a dog. You put in a skylight because you want more light. You plant tiger lilies and hyacinth in the yard because they are the most beautiful flowers in the world. You create a stable and nurturing environment for raising your children.

In your own home you control your own destiny.

Moreover, it is through home ownership that you secure your financial destiny. By and large, everything you buy in life loses value quickly–your car, your furniture, your clothing. But not so with your home. The family home is, for most families, the biggest nest egg they will build in their lifetime.

At a minimum, owning a home–with a fair mortgage–locks in and caps your monthly housing expenses. That is a great deal compared to renting, where rents go up and up over the years.

In addition, your monthly payments steadily pay off your mortgage, you own an increasing share of your home, and the bank owns less.

You can look down the road and see the possibility of owning your home free and clear before you retire, making it possible to get by decently in your golden years. To make the deal even better, your home appreciates in value. The home you bought for $80,000 in 1980 might be worth $250,000 in 2010. In many cases, it might be that appreciation, that growing home equity, that enables you to travel a bit during retirement, or that enables your son or daughter to afford to go to college.

So homeownership really is a magical part of the American dream–opening the door to our aspirations and building our financial fortunes. Thus, you would expect that our leaders would do all they could to protect and advance homeownership.

Unfortunately, however, I am here today to say that we really haven’t done such a good job. In fact, all too often this past decade, we have allowed the great American dream of homeownership, to turn into the great American nightmare. We can and must do better.

What has gone wrong? In short, almost everything.

Most fundamentally, we have abused one of the most amazing inventions, one of the most powerful wealth building tools, we have ever seen: The fully amortizing mortgage.

Let’s turn the clock back 77 years to the Great Depression. Before 1932, house loans were normally 50 percent loan to value with 3- to 5-year balloon payments. This worked fine as long as a family could get a new loan at the end of 3 to 5 years to replace the old loan. With the crash of our banking system in 1929, however, replacement loans were no longer available. Thus, as balloon payments came due, millions of families lost their homes.

The solution was the fully amortized mortgage, which eliminated the challenge of replacing one’s mortgage every 3 to 5 years, thereby insulating families from frozen lending markets. Indeed, the Roosevelt administration’s decision to help millions of families replace their balloon loans with fully amortized loans was a major factor in ending the Great Depression and putting our national economy back on track.

This system of amortized mortgages worked very well for over half a century. But in recent years, we have allowed two developments that have deeply damaged the stabilizing power of the amortizing mortgage and helped produce our current economic crisis. Those two factors are tricky mortgages and steering payments.

One tricky mortgage, for example, was the teaser loan–sometimes called the “2-28” loan. In this loan, a low introductory rate exploded to a much higher rate after 2 years. In many cases, the broker knew that the family could never afford the higher rate, but the broker would persuade the family that the mortgage presented little risk since the family could easily refinance out of the loan at a later date. This argument was misleading, of course, since the family was locked into the loan by a sizable prepayment penalty.

Another tricky mortgage was the triple-option loan, in which a family could make a month-to-month choice between a low payment, a medium payment, or a high payment. What many families didn’t understand, however, was that the low payment could only be used for a limited period before the family was required to make the high payment, which the family couldn’t afford.

These tricky loans, however, would probably not have done much damage, because their use would have been rare–except for a second major mistake; namely, we allowed brokers to earn huge bonus payments–unbeknownst to the homeowner–to steer unsuspecting homeowners into these tricky and expensive mortgages.

These secret steering payments turned home mortgages into a scam. A family would go to a mortgage broker for advice in getting the best loan. The family would trust the broker to give good advice because, quite frankly, they were paying the broker for that advice. The payment to the broker was right there, fully listed and disclosed by law, on the estimated settlement sheet.

But what the borrower didn’t realize was that the broker would earn thousands of bonus dollars from the lender–so called “yield-spread premiums”–if the broker could convince the homeowner to take out a tricky expensive mortgage rather than a plain vanilla 30-year mortgage.

This scam has had a tremendous impact. A study for the Wall Street Journal found that 61 percent of the subprime loans originated in 2006 went to families who qualified for prime loans. This is simply wrong–a publicly regulated process designed to create a relationship of trust between families and brokers, but that allows payments borrowers are not aware of that stick families with expensive and destructive mortgages.

It is difficult to overstate the damage that has been done by these tricky loans and secret steering payments.

An estimated 20,000 Oregon families will lose their homes to foreclosure this year.

Nationwide, an estimated 2 million families will lose their homes this year and up to 10 million over the next 4 years.

In every single case, the foreclosure is a catastrophe for the family. Each foreclosure is a shattered dream. The family has lost its financial nest egg. It has lost the nurturing environment the parents created for the children. The family has lost its dream of building a foundation for retirement. And don’t doubt for a second the stress that this catastrophe places on the parents’ marriage, or on the children, multiplying the damage.

The foreclosure is also a catastrophe for the neighborhood, because an empty foreclosed home can lower the value of other homes on the street by $5,000 to $10,000.

The foreclosure is, in addition, a catastrophe for our financial system. A lender often loses half the value of the property by the time it has been publicly auctioned.

And as we now know all too well, foreclosures undermine the value of mortgage securities and mortgage derivatives, damaging the balance sheets of financial institutions in America and throughout the world and throwing our banking system and global economy into chaos.

That frozen lending and economic chaos, of course, further hurts our families. Oregon’s unemployment rate has gone from 6 percent to 11 percent in just 5 months, nearly doubling the number of Oregon families out of work, and unemployment, in turn, drives additional foreclosures.

How did we let this happen? This fiasco is, first and foremost, the consequence of colossal regulatory failure. Let me count the ways.

First, in 1994, Congress required the Federal Reserve Board to prohibit mortgage lending practices that are abusive, unfair or deceptive. That was a very good law. But for 14 years, the Fed sat on its hands, failing to regulate abusive and deceptive practices such as teaser loans, prepayment penalties, and steering payments.

Second, in 2002, after the State of Georgia adopted comprehensive mortgage reform legislation, the Comptroller of the Currency, John Hawke, overturned the Georgia reforms and banned all States from making such reforms affecting federally chartered institutions. This action made it difficult for States to pass reforms covering State-chartered lenders as well, since such action generated the powerful argument that it would create an unfair disadvantage for State-chartered banks. I can testify to this firsthand because that is exactly what happened when last year, as Speaker of the Oregon House, I worked to pass such mortgage reforms in Oregon. As a former attorney of North Carolina summarized it, the Office of the Comptroller of the Currency “took 50 sheriffs off the job during the time the mortgage lending industry was becoming the Wild West.”

The third failure was in 2004. The Securities and Exchange Commission exempted the five largest investment banks from its leverage requirements. This dramatically amplified the funds available to the banks to purchase mortgage-backed securities, funding a tsunami of subprime loans. Let’s take a look at a chart.

We see that impact in 2004, when subprime loans, which had been at a relatively stable level, grew dramatically and suddenly. To make it worse, the Securities and Exchange Commission failed to regulate credit default swaps, which became a $50 trillion industry, that contributed to the appeal of mortgage-backed securities by insuring those securities against failure.

The fourth failure was in the Office of Thrift Supervision. That office was asleep at the switch. The office failed to halt risky lending practices that doomed numerous thrifts. An inspector general’s report after the failure of NetBank in September of 2007 concluded that the Office of Thrift Supervision ignored warning signs about the bank’s risky lending. OTS continued to snooze, however, while numerous thrifts failed, including IndyMac, Washington Mutual, and Countrywide.

The fifth failure. While Fannie Mae and Freddie Mac set standards limiting their purchase of subprime mortgages, they nevertheless poured fuel on the subprime fire by investing in subprime securities, thereby driving the financing of the subprime market.

Taken together, these five circumstances composed a colossal failure of regulation. Even Alan Greenspan, former Chair of the Fed who prominently advocated that banking practices should not be regulated because Wall Street, in its own long-term interest, would regulate itself, now renounces that philosophy.

I say to my friends and colleagues, what a mess. Congress got it right in 1994, when it asked the Fed to prohibit mortgage lending practices that were abusive, unfair, and deceptive. But Congress shares the responsibility for not following up aggressively when the Fed failed to act on this requirement.

The result is that home ownership has suffered and our national economy is in deep trouble. So now is the time for us to honestly assess the damage and to repair the damage as best we can. It is time to end the deception and abuse in Main Street mortgages and in Wall Street mortgage securitization.

The American dream of home ownership, with all that it means for the quality of life of our families, depends on our effective action.

To repair the damage, we need to support aggressive efforts to enable families trapped in subprime mortgages to negotiate modifications to those mortgages. President Obama and his team have taken many steps in the right direction on this issue, but we need to monitor the progress and help pave the way for success.

If mortgage modifications fail due to the extraordinary difficulty of connecting borrowers to lenders in a market where the loan has been sliced and diced into 100 pieces, we need to support the ability of bankruptcy judges to operate as an arbitrator to adjust the terms of the loan. We grant this power to judges for loans for yachts, loans for vacation homes for our more privileged citizens. Certainly, ordinary citizens should have the same recourse for a far more important possession–the family home.

Consider the experience of Lisa Williams, who spoke at a mortgage foreclosure summit I hosted in Oregon last month. Lisa spoke about the lengths to which she went to get in touch with someone to help her renegotiate her loan. She would call and call her bank and never get through or she would be put on hold for more than an hour at a time or, on the rare occasion that she did get through, she could not reach anyone in a position of authority to talk with her. Five months ago, despite her innumerable and consistent efforts, she lost her home. An aggressive loan modification program or a last resort–and I stress last resort –bankruptcy arbitration would have saved Lisa’s home and, looking forward, would save the homes of millions of other American families.

We also need to restore the same guidelines to Wall Street–cap excessive leverage, regulate credit default swaps, prevent the creation of firms too big to fail, end regulator shopping, and evaluate and control systemic risks.

Finally, we need to end deceptive and abusive mortgage practices. The regulations adopted by the Federal Reserve last year are a decent start. It is time for us to make sure teaser loans, triple option loans, and secret steering payments never again haunt American families.

I say to my friends and colleagues, I end this appeal as I started it. Let us rally to the defense of the American home. We will have that chance when we consider legislation in the near future addressing mortgage practices. As we prepare to do our thoughtful best to craft mortgage and housing policy that will strengthen our American families, we might do well to consider the advice of President Franklin Roosevelt, since it was, indeed, Roosevelt who steered us out of the Nation’s last enormous housing crisis.

Roosevelt, speaking in his April 2, 1932, radio address entitled “The Forgotten Man,” declared:

“Here should be the objective of Government itself, to provide at least as much assistance to the little fellow as it is now giving to large banks and corporations.”