Floor and Committee Statements

Monday, February 1, 2010

U.S. Senator Johnny Isakson (R-GA)
Floor Statement on the Unintended Consequences of Well-Intended Regulation
Remarks as Delivered on the Senate Floor

Mr. President, I rise tonight following on the heels of three more bank closings in my State last Friday; not new banks, one of them over 60 years old, one of them over 100 years old. I want to talk for a few minutes tonight about the unintended consequences of well-intended regulation.

We are now going into the 26th month of the current recession. This will arguably be the longest recession post-World War II America has experienced. I can tell you from having gone through four of the recessions post-1960, this is by far the worst of anything that we experienced. We are at a point where we have to make some good, solid decisions, but we have to help our economy, help our businesses, and help our financial institutions.

Don't get me wrong at the outset. I am not talking about waiving or dispensing or looking the other way. I am not talking about loosie-goosie regulation which got us into the mess we are in: shoddy underwriting and poor credit. But what I am talking about are realistic approaches to difficult problems and looking to our past to understand the answers for our future.

I wish to talk about rule 114, which is called mark to market. Mark to market is where an appraisal of an asset held by a bank is appraised at what it would sell for today, and in many cases because of a difficult real estate market, in both commercial and residential, those values are dramatically depressed, in most cases below the loan that is against them. So the asset deteriorates, the asset side of the balance sheet of the bank deteriorates, and you have difficult problems.

In the late 1980s and early 1990s we had a similar period of time. We had something called the Resolution Trust Corporation, the RTC. It was kind of a bad bank that took all the assets of the failed savings and loans around the United States. We waived mark to market for 3 years. We had a 3-year moratorium so the banking institutions and their regulators could deal with loans in a practical, pragmatic way rather than Draconian, rigid application of mark to market.

Second, we have to consider doing something on the appraisal rules that have been passed down. I have talked to our Secretary of HUD on this matter, and I intend to talk to him more about it. I was in Clayton County, GA, south of Atlanta, just 2 weeks ago, a county that has been hit hard by the housing recession, a county where values are 42 percent below what they were in 2006. That is a significant decline.

I talked to one realtor after another and one lender after another who told me the interesting thing that has happened. With the new appraisal regulations, the appraisals on these houses when they sell at a short sale or foreclosure are coming in at exceedingly low values. But when the people have to get their homeowners insurance to insure the house, they are having to insure the house for more than they paid for it. Why? Because you can buy houses in Georgia today or around the country for less than what it costs to replace them.

When I entered the business in the 1960s, cost to replace was the principal way real estate was evaluated. Later, comparable sales took over cost to replace. I think it is time we look at cost to replace becoming the primary mechanism for establishing lending and insurance purposes.

The short sale situation is another problem. It has taken banks in some cases 10 to 12 months to give somebody an answer on a short sale. A short sale, for those listening, is when you have a house and you are in default, you can't pay your loan but it is not in foreclosure yet, you find a buyer who can pay 80 cents on the dollar.

Say you owe $100,000, and they can pay $80,000. You go to your bank and say: Will you take $80,000 and forgive the $20,000 and let me sell this property rather than foreclose it? Banks are reluctant to make decisions and most of the time, therefore, they didn't. Those houses they could have sold on a short sale go into foreclosure. When they go into foreclosure, more often than not they are vandalized. Their value declines 1, 2, 3 percent a month and the house comes out at an even lower value.

To show you the value of some well-intended regulation, I want to commend the Treasury because last week the Treasury issued a ruling to banks that received TARP money that they must respond within 10 days on any short sale offer on a mortgage that bank holds. We are going to see a remarkable change in Denver, in Atlanta, in Houston, and a lot of other places. We are going to see some sales that have not been taking place start to take place. We are going to see some inventory reabsorbed. I commend the Treasury on their good approach to short sales.

I wish to talk a minute about loss-share. The FDIC has come up with a loss-share proposal for the banks that take the troubled assets of banks that have failed. FDIC says: If you will take these assets, we will guarantee the most you can lose is 20 percent on the value. We will cover the other 80. But to make sure we do not get in worse trouble, you cannot extend credit beyond 10 percent of the debt owed to the borrower.

The problem with that is a lot of these assets are, in fact, performing, but they have not been completed yet. To complete the asset so it begins to pay back, sometimes you have to extend credit beyond 10 or 15 or 20 percent. To have an absolute rule that you cannot is causing loans to go bad or to go unfunded that otherwise should have been funded.

In 1974, we went through a housing recession as deep and as problematic as the one today. Foreclosures were every bit as rampant--maybe not as big in numbers but as rampant and as difficult. As is beginning to happen now, the commercial loans began to fail in 1975.

An interesting thing happened around the country. Commercial lenders and the regulators recognized very quickly if they foreclosed on commercial loans like they had foreclosed on residential loans, the banking system would collapse; the asset side of almost all banks would collapse. So what they decided to do was encourage banks to work out these assets by going to the developer who was in trouble, who owed the money, and say: I'll tell you what. If you deed this property back to us in lieu of foreclosure and then let us hire you on an earned-out process so we can develop our way out of this debt rather than foreclose ourselves into a loss--and more often than not, probably three out of every four transactions, it happened.

The house I live in today I built on a lot I bought in a subdivision that had been taken back by the C&S National Bank. They had hired the developer to do a workout. I bought it at a good price and later did most of the sales in the development. It became a great development, and the bank eventually was made whole. The bank would have lost lots of money if they had to take that thing and foreclose on it and had not worked it out.

I encourage our regulators to give the great American ingenuity and entrepreneurship the chance to work. Sure, some of these people are in trouble, but there are avenues outside of that trouble.

There has been a lot of talk about taxing banks that receive TARP money. I want to address that for a second because, the best I can tell, every bank that has received TARP money is paying it back at a 5-percent dividend. We are making a profit. The only people who have not paid it back are GM and Chrysler, who probably never will. But if we put that much more of a burden on top of the people who are paying us, and paying a premium when we have a banking system under stress and duress, it is only making it more and more impossible for them to stay in business, for them to be vibrant and come back to bring credit to our communities.

On that point, with mark to market enforced at a Draconian rate, with appraisal rules driving down the values of properties that are financed by the banks, with the regulatory environment being so stiff to recognize losses and deteriorate the balance sheet, there is not any credit for small business to speak of.

We are making a recession that is deep, that is broad, and that is pervasive worse because of the unintended consequences of well-intended regulation.

Last, I have enjoyed working with Senator Kaufman so much over this issue of short sales that I just want to put in one more plug for what we plugged in this entire session and encourage the SEC. In the collapse that took place in the markets, one of the things that went out of hand was the short selling of financial stocks to terrible lows. That short selling took place in large measure because there was no uptick rule, which was the old rule that was good for years on the stock market that once you had a declining value in the stock, if it ticked up on a trade, you stopped the short selling from continuing to take place.

We need the SEC to revisit it. They took 30 days a year and a half ago and suspended it and it helped, but we don't need those speculating in the marketplace to take unfair advantage of the values of equities that are owned by Americans all over this country for the sake of making a buck on a short sale.

My remarks are very simple. There are unintended consequences to regulation, and we need to start looking at the cause and effect. Where we can find opportunities for banks to work out, for mark to market to be suspended, for appraisals to be based on cost to replace rather than comparable sales, we will begin to give the flexibility to the banking system to begin to recover, to stop the losses, stop the failures and, over time, recover our economy.