Cautious plan for mortgage crisis
Amid new signs of financial turmoil, the Bush administration Thursday raised the prospect of tighter regulation of U.S. financial markets. But it once again stopped short of the step its critics are demanding -- sweeping government intervention in the worsening economic crisis.
For weeks, it has been clear that the administration would have to offer new initiatives to offset fears that America’s credit system could lock up. Around the world, financial markets have gyrated. The domestic economy has shown new signs of recession. And congressional leaders have pushed ahead with plans for decisive government action.
But the package of proposals unveiled with much fanfare by the Treasury Department on Thursday was in large measure a call for greater self-policing by the financial industry.
Treasury Secretary Henry M. Paulson Jr. portrayed the plan as part of a carefully calibrated push to bolster the system’s sputtering regulatory apparatus enough to deal with rapidly changing and highly unstable financial and mortgage markets.
“Regulation needs to catch up with innovation and help restore investor confidence, but not go so far as to create new problems [or] make our markets less efficient,” Paulson said at a Washington news conference.
The plan was widely greeted as too little, too late. Even its most specific element -- a call for states to license the brokers who sold millions of overpriced, undersecured mortgages that form the core of the larger crisis -- was met with doubt.
“I’m skeptical,” said Bert Ely, a conservative and widely respected expert on financial regulation. What’s needed is not licensing, Ely said, but a simple rule: “He who makes a loan keeps the risk.”
Thursday’s developments in Washington came amid mixed signals from the global economy. The dollar hit new lows on international markets, trading at less than 100 Japanese yen for the first time in 12 years and at $1.56 to the euro -- the lowest since the European currency was issued in 1999.
The greenback’s decline drove gold futures briefly above $1,000 an ounce for the first time ever as investors sought shelter from the currency upheaval. Gold ended at $992.30, up $13.50.
Traders were also unnerved by an unexpected drop in retail sales and news that Carlyle Group’s mortgage bond fund, Carlyle Capital Corp., had defaulted on about $16 billion in mortgage-related debt.
Looking back, most economists think the mortgage problems were rooted in the fact that loan brokers were rewarded for the volume of borrowers they brought in, not the borrowers’ ability to pay. And because the actual loans were made by banks, which then sold them to be bundled into securities and sold yet again, the brokers never suffered for putting together bad deals with financially unstable borrowers.
On the political front, Democrats were quick to signal their dissatisfaction.
“The good news is [that administration officials are] beginning to put their toe in the water when it comes to government involvement to help the economy,” said Sen. Charles E. Schumer (D-N.Y.), chairman of Congress’ Joint Economic Committee.
“The bad news is they’re going to have to do a lot more than that to address the problem,” Schumer said of the latest administration proposals.
Congressional Democrats showed what they thought a central element of that agenda must be in announcing a proposal Thursday for the government to guarantee as much as $300 billion in mortgages. In return, lenders would have to write down loan principals to reflect current values, which would help strapped homeowners afford their monthly payments. The measure is designed to help as many as 2 million troubled borrowers.
The plan’s authors -- Rep. Barney Frank (D-Mass.), chairman of the House Financial Services Committee, and Sen. Christopher J. Dodd (D-Conn.), chairman of the Senate Banking Committee -- said their measure would not involve the direct expenditure of taxpayer funds.
But independent analysts said the offer of a government guarantee would put Washington in line to spend taxpayer funds if borrowers couldn’t make good on their mortgage payments.
Frank appeared to acknowledge the point. “We’re going to try to make this as least likely a loser for the government as possible,” he said at a news conference.
That sets the stage for a major clash between congressional Democrats and the administration. Paulson said this month that any proposal to help troubled borrowers that involved taxpayer money was a “non-starter.”
From the beginning of the crisis last summer, when high-credit-risk homeowners with sub-prime mortgages started defaulting in droves, Paulson and his boss, President Bush, have sought to limit Washington’s role to one of bringing the various private-sector players together to hammer out voluntary fixes.
Even when the crisis spread from the narrow confines of sub-prime loans to a wide variety of mortgages and complex financial instruments such as “structured investment vehicles,” the administration remained adamant that the private sector should work out its own solutions, with the government acting as a sort of cheerleader or coach.
The same thinking was reflected in much of the administration’s latest proposal, the product of a presidential working group that included representatives of virtually all the government’s major financial regulatory institutions, among them the Treasury, Federal Reserve, Securities and Exchange Commission and Commodity Futures Trading Commission.
For example, the group said that a key problem behind the crisis was that credit rating firms, which are supposed to assess the risk or safety of financial instruments to help investors, did a poor job with sub-prime mortgage-backed securities and similar instruments, and in some cases may actually have helped securities issuers get around difficulties to win triple-A ratings, indicating that their products were considered very safe.
Among the recommended fixes: The presidential working group “will facilitate formation of a private-sector group . . . to develop recommendations for . . . steps that the [securities] issuers, underwriters, [credit rating firms] and policymakers could take to ensure the integrity and transparency of ratings.”
Similarly, the working group said another problem was that some major U.S. and European financial institutions had poor risk-management methods, so they did not know how dangerous the securities they held were until the crisis hit. By that time it was too late for them to protect themselves. The group “will support formation of a private-sector group to reassess . . . existing guiding principles.”
The Paulson-led working group also called on market players to disclose more information about their operations. But the disclosures are largely aimed at giving investors more to work with in making their investment decisions, not at helping regulators decide whether to impose new rules or penalties.
The group did call on regulators to step up oversight of financial institutions and issue new rules. For example, it said the Fed should come up with “stronger consumer protection rules and mandate enhanced . . . disclosures.” But asked at a background briefing whether the group’s recommendations would require that any new laws be passed, a Treasury official said, “I don’t think the policy statement is changing existing law.”
Given the general cautiousness of the group’s proposals, Vincent Reinhart, a former senior Fed official, was asked why he thought the administration released the proposals with such fanfare. He said that at least part of the reason was to try to short-circuit moves by congressional Democrats.
But Reinhart, now with the generally conservative American Enterprise Institute, a Washington think tank, doubted that Paulson and the administration could hold off calls for direct action.
“The financial sector needs more capital. This proposal does not solve that. If things work out, the capital will come from within the private sector,” Reinhart said.
But if they don’t, he added, “we might need a government solution.”
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maura.reynolds@latimes.com
