Defense of the American Home

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.”