The Economy

Floor Speech

THE ECONOMY -- (Senate - September 18, 2008)

Mr. SCHUMER. Today I rise to discuss the recent turmoil in our financial markets. Over the past few days the upheaval in New York has been extreme, as we have witnessed the bankruptcy of Lehman Brothers, one of the oldest and most well-respected financial institutions in the world, the purchase of Merrill Lynch by Bank of America, and the Government takeover of AIG, America's largest insurance company.

Those stunning developments followed closely on the heels of the Government takeover of Fannie and Freddie a mere 10 days ago. And I watched with great sadness those lining up at some of these companies to take their belongings away after years and years of work and heard the tales of woe from my constituents.

Our job here is to cushion the blow for those who are innocent of any wrongdoing and have lost their jobs. I am trying to do all I can to minimize job loss in New York. But it is also to prevent this from happening again. That is why I rise to speak today, to lay out an outline of principles, and a broad-brush plan that might help us deal with this crisis.

These unprecedented events have made it clear to the country what many of us have been saying for some time. We are in the midst of the greatest financial crisis since the Great Depression. After 8 years of deregulatory zeal by the Bush administration, an attitude of ``the market can do no wrong'' has led it down a short path to economic recession.

From the unregulated mortgage brokers to the opaque credit default swaps market to aggressive short sellers who are driving down prices of even healthy financial institutions based on innuendo, this administration has failed to take the steps necessary to protect both Main Street and Wall Street.

There may not be a silver bullet to fix what is currently dragging down the economy, but we can take steps to mitigate the costs and ensure that the impact of this crisis will be short term. We need to offer a smart, targeted, and timely solution that will help our economy weather this storm and keep as many families from losing their homes in the process as we can.

Every minute matters, and the future competitiveness of the U.S. economy depends on the administration's response. The series of ad hoc interventions in the market over the past 10 days were important to avoid a systemic disaster, but we cannot continue to act in such an uncoordinated and ad hoc fashion.

Furthermore, the Federal Reserve is being asked to do things that go far beyond its mission. I represent 19 million New Yorkers, many of who live on Main Street and work on Wall Street. So I know better than most that our response has to be aimed at both areas. It must protect the downstate economy, and the upstate economy. And the two--whatever one feels or wants to say--are intrinsically linked. Make no mistake about it. The reckless lending practices and irresponsible risk taking conducted by many of our financial institutions during this era of deregulation have proven costly for the U.S. economy and its taxpayers.

The Federal Government cannot and should not write a blank check to the institutions that have exacerbated this crisis. The U.S. taxpayers have already extended $300 billion worth of capital to troubled banks and financial institutions, asking for nothing in return.

So starting today we need to condition the Federal Government's financial lifeline on the institutions' firm commitment to take actions to get us out of our immediate economic crisis. If the Federal Government is going to continue to support the economy, its new formal lending program with financial institutions must address both the need for restoring stability and confidence in the U.S. financial market, and the need to set a floor in our plummeting housing market.

Some people focus on one, some people focus on the other. The fact is we need both. We are not going to get out of this great mess unless we deal with the mortgage crisis and the homeowner, and we deal with the cycles in our financial system which not only affect Wall Street and its jobs, of course, and my constituency, but affect all of America, because lending is the lifeline of the economy.

Someone from Chrysler told me that right now you need a FICO score of 720--that is a credit rating that is very high--to get an auto loan. If that continues, we would only sell 10 million cars in America next year as opposed to the 15 or 16 million we sell now. That shows you the interrelationship right there. The auto worker is related to the financial institutions. We must fix both in a practical, nonideological solution aimed at getting our economy back on its feet.

The rapid deterioration of the financial sector is fueled by the steep rise in delinquencies and the foreclosure of risky mortgages that have been sliced and diced and sold in complex instruments that are becoming rapidly toxic waste on the balance sheet of our largest financial institutions.

The best way to stop the bleeding is to turn these mortgages into viable assets on a large scale. But the combination of an economic downturn, tumbling home prices, complex mortgage security, and irresponsible underwriting by unregulated mortgage brokers has made this a daunting and so far insurmountable challenge.

Over the past few years we have heard many discussions of a so-called RTC, Resolution Trust Corporation, and RTC-like proposals modeled after the Government-owned asset management company charged with liquidating assets after the 1980s S&L crisis.

Today, Senator McCain made a similar proposal. And before I address that, let me speak for a minute on Senator McCain. He has been a leading advocate for deregulation for a very long time. All of a sudden, he sounds almost like a populist. He seems to reverse course day in and day out.

Two days ago he said: AIG should not be aided by the Government and should go bankrupt. And today he is calling for large Government intervention in the financial markets. It is no wonder that Senator McCain said he does not understand economics. His erratic behavior in the last 2 days is inconsistent--saying one thing on Tuesday and another thing almost directly opposite on Thursday--makes you understand why people would not trust him with the economy.

Today he called for the firing of Chris Cox of the SEC. Well, I have a lot of differences with Chris Cox and with the SEC. They have been far too deregulatory to me. But where does Senator McCain differ in policies with Chris Cox? Does he have a different view on short selling? Does he have a different view on holding company regulations? Who knows? Maybe he will replace Chris Cox with Phil Gramm who considers someone who lost his job a whiner, and considers all of us hurting in this economy a ``nation of whiners.''

It is hard to take the proposals by Senator McCain very seriously unless he backs them up, not only with detail, but with consistency and a philosophy.

But getting back to his proposal today, something of an RTC-like company, the central challenge with that approach, and anyone who is advocating the RTC--and my colleague Senator Dodd has outlined this very well recently--is that the Federal Government would take on all of the risk of the bank's troubled assets without addressing the root of the problem, the housing market.

Proposals such as Senator McCain's may help Wall Street but they will do nothing for Main Street. Two major problems exist. First, troubled mortgages have been sold into complex mortgage-backed securities which have themselves been split into pieces and sold to thousands of investors around the world.

In order for an RTC to be able to modify the mortgages, it would have to gather up all of the pieces of every security and put the proverbial puzzle back together. This would be incredibly difficult and virtually impossible. That is why the proposals by Secretary Paulson, as well intentioned as they are, have done very little in the foreclosure area. Because if one investor of the hundreds who hold a piece of a mortgage says ``no,'' there can be no refinancing, no reformulation. It is a huge problem.

Second, even if it were possible for borrowers to have piggyback loans on second mortgages, which is an estimated 50 or 60 percent of the troubled mortgages, the RTC would have to go back and buy the second lines as well in order to work out the loan.

In other words, even with the first mortgage, if you could get all of those hundreds of pieces together, there is a second mortgage in 50 to 60 percent of these troubled mortgages and the second mortgagors or mortgagees are not going to stand for--the first mortgagors are not going to stand for reducing their mortgage while the second mortgage is as large as ever.

In short, the complex structure of the most troubled mortgages underwritten over the past several years would prevent an RTC from being able to help most homeowners. Furthermore, it seems like the RTC is Rashoman these days.

Some propose the name ``RTC'', like the Wall Street Journal financial page, to buy financial instruments; some propose it to deal with the mortgage situation, which is difficult, as I mentioned. And I think when we look at the specifics, the RTC model is not the best way to go. In fact, it might not work at all.

Therefore, I am proposing that we examine a two-part approach that will help suffering homeowners across the country keep their home and restore stability to Wall Street.

First, we must get banks and other financial institutions to drop their fierce opposition to judicial loan modification in exchange for any additional assistance from the Federal Government.

This year my colleague, Senator Durbin, led legislation in the Senate that many of us cosponsored that would make a simple change to current law to allow judges the authority to modify harmful mortgages on primary residences. The industry adamantly lobbied against this legislation, arguing it would harm the secondary mortgage market. Simply put, this is wrong. Between 1978 and 1993, when such modifications were allowed, the evidence is clear. It had no impact on the secondary mortgage market whatsoever. What is even more absurd, a judge can already modify a mortgage on a second home. So if you own two homes--or seven homes--the bankruptcy court can help. But if you are like Joe and Eileen Bailey and most of us and you only have one home, which is, by the way, also your largest and most important asset, and you find yourself in trouble, there is nothing a bankruptcy judge can do.

This critical solution is achieved by simply removing the bankruptcy law's language that denies relief to homeowners for their primary residence. Court-supervised loan modification is the simplest, fairest, and least expensive way to get all the parties of a mortgage together and modify the loan down to the fair market value of the home with no cost to the U.S. Treasury. This provision also guarantees the lenders at least the value they would obtain through foreclosure, since a foreclosure sale can only recover the market value of the home. In addition, it saves lenders the high cost and significant delays of foreclosure. Because bankruptcy is enshrined in the Constitution and because the bankruptcy judge has the power, unlike the mortgage processor, to require all the parties to come together, this can work and, again, at no cost to the Federal Government.

Second, to restore confidence in financial markets and institutions, rather than continuing to intervene on an ad hoc basis as additional companies face problems, we should look at options to formalize ways for the Federal Government to provide capital injections and secured loans for banks that are struggling. This will give financial institutions the capability to de-lever their balance sheets and write down their bad assets over time. The rapid failure of a large number of financial institutions would have a disastrous long-term effect on the American economy, a situation we must avoid at all cost. The Government could establish a new agency similar to the Reconstruction Finance Corporation or RFC-like model employed during the Depression. The RFC is far preferable to RTC. But we must condition the development of this formal structure on the agreement of banks to abandon their opposition to judicial loan modifications, and not only banks but others who hold pieces of mortgages as well. An RFC-like agency would receive equity and possibly secured debt from the banks in return for providing capital or liquidity. The equity received by the Government would allow the Government to share in any upside appreciation of the banks and minimize taxpayer costs in the process. The RFC would also get some degree of oversight lending activities of banks it has invested in, and the Government would come first. The Government would get repaid before others in the financial chain.

I represent the State of New York where many of my constituents live on Main Street and many work on Wall Street. Both are in dire trouble. We have the largest city in the country, and we are the financial capital of the world. We have upstate New York which would be the seventh or eighth largest State in the country. In addition, we have the third largest rural population. Right now all are in trouble because in this complicated economy all are interrelated. We have a responsibility to address the problems faced by both homeowners and financial markets. Attempts to solve only one side of the equation will not get us out of this crisis. Without a comprehensive solution that helps keep people in their homes, no amount of money advanced by Uncle Sam will restore the fundamental strengths of the American economy.

Chairman Bernanke has said it over and over again: Until we solve the mortgage problem, we are not going to solve our economic or even our financial problem. But unless we also solve our financial problem, the economy will not recover, and the housing problem will get worse. So we need to do both. Those who say just do one or the other, for ideological or policy reasons, will not come up with a solution. The solution I have proposed does both, and it links the two. To those who say the Government can't get involved in these institutions for no cost, we are making sure there actually is a cost, not only in the repayment plan but in the fact that they will have to treat mortgages differently and help beleaguered homeowners. By doing that, they will help the economy.

To those who propose a plan of just helping the homeowner, worthy as that is and as much as I have worked hard and believe in it, if our financial institutions and our financial lifeblood continues to be brittle, frozen, and sparse, it will be far more difficult to solve the homeowner problem because the economy will get worse, housing prices will go down, and the cost and ability to keep mortgagors in their home will be less.

This solution represents the best way to get us out of our financial crisis in a comprehensive way. It should have appeal to those on both sides of the aisle. Most importantly, it is a solution that deals with the entirety of the problem in a comprehensive way.

Given our economy hurtling southward, given the horrible stories we read in the newspapers every day about those who work on both Main and Wall Streets hurting, we cannot afford not to act.

I yield the floor.

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