White House proposals target risky mortgage practices

WASHINGTON – Working to stabilize the financial markets, the Bush administration announced a series of new proposals today designed to curb risky mortgage practices and help Wall Street cope with the fallout in credit markets.

Treasury Secretary Henry M. Paulson Jr. blamed a “dramatic weakening of underwriting standards” for triggering the collapse of the sub-prime mortgage market, which has spread through the rest of the credit markets, making loans virtually unavailable and led to large write-downs of mortgage losses by major financial institutions.

“Weaker sub-prime credit standards were part of a much broader erosion of standards throughout corporate and consumer credit markets,” Paulson said in a speech outlining the new measures. “We have had a number of years of benign economic financial conditions and abundant liquidity; investors reached ever further for yield, and market participants and regulators became complacent about all types of risks.”

The proposed measures were largely in line with plans already accepted by mortgage lenders and financial institutions, including regulating mortgage brokers and ensuring that credit ratings more accurately reflect risk to investors.

The stock market continued its roller-coaster reaction to bad economic news, with the Dow Jones industrial average dropping nearly 200 points in the first hour of trading this morning before recovering slightly.

The index had risen more than 400 points earlier in the week on news that the Federal Reserve would lend about $200 billion to financial institutions to shore up their balance sheets, but appeared unnerved today by a further decline in the value of the dollar, retail sales reports that were lower than expected, and the nearing collapse of Carlyle Capital Corp., a mortgage bond fund.

Paulson indicated that the administration is also concerned about the new dangers to the economy from the weakness of mortgage bond funds like Carlyle, which held about $21 billion in mortgage-backed securities.

“There is a certain irony that during this period it has been the regulated financial institutions which have been the focus of our attention,” Paulson said. “With a few exceptions, the hedge fund sector thus far has proven resilient to market volatility and protracted illiquidity. We know that a number of hedge funds are now also facing difficulties, as some are missing margin calls, and we are monitoring that closely.”

Paulson said the new measures, which he expects government regulators to begin implementing in coming months, would include national licensing standards for mortgage brokers, better consumer disclosure and stiffer oversight of mortgage originators.

“This effort is not about finding excuses and scapegoats,” Paulson said. “Those who committed fraud or wrongdoing have contributed to the current problems; authorities need to and are prosecuting them. But poor judgment and poor market practices led to mistakes by all participants.”

On another front, he added: “Mortgage brokers will be held to strong national licensing and enforcement standards. There will be stricter safeguards against fraud, and full and clear disclosure to borrowers about home loan terms, including long-term affordability.”

Investors must also take a more active role in evaluating risk and cease to rely on credit rating agencies, whose practices have come under criticism for being too lax.

“Many investors became complacent about risk and they have learned a costly lesson, one that amplifies the need for thorough due diligence. In fact, it seems that today’s risk aversion is an aftermath of yesterday’s risk complacency,” Paulson said.

The Treasury Department planned to release more details about the proposals later in the day.

“No silver bullet exists to prevent past excesses from recurring,” Paulson said. “We will continue to reassess conditions, monitor progress, put forward new recommendations and take additional steps as necessary.”

Paulson’s proposals were welcomed by industry groups, which had advised the administration in drafting them.

“We agree with Treasury’s recommendation that mortgage brokers should be held to stronger licensing and enforcement standards and that stricter safeguards against mortgage fraud should be put in place,” said Kieran P. Quinn, chairman of the Mortgage Bankers Assn. “Furthermore, we agree that borrower disclosures, including a better disclosure of mortgage broker compensation, are critical and we will continue to work with policymakers to streamline, improve and simplify disclosures.”

Sen. Charles E. Schumer (D-N.Y.), chairman of the Joint Economic Committee, complained that the administration was slower than Congress to respond to the crisis.

“The administration is finally moving toward where Congress was last year,” he said. “The good news is, they’re beginning to put their toe in the water when it comes to government involvement to help the economy. The bad news is, they’re going to have to do a lot more than that to address the problem.”

maura.reynolds@latimes.com

peter.gosselin@latimes.com