WASHINGTON — A presidential working group issued a broad set of proposals Thursday to correct weaknesses in the way homes are financed so that the sort of problems now crippling the nation's housing sector won't recur.
The President's Working Group on Financial Markets recommended changes in virtually every area of mortgage finance. It called for tougher state and federal regulation of mortgage lending and mortgage brokers. It also supported creating a national licensing standard for anyone who originates mortgages.
Its report is notable, however, for its restraint in expanding federal regulation: the national licensing scheme, for example, still would depend on enforcement by states. Weak local enforcement is one major reason that the housing market grew into a bubble and then burst.
The report also didn't propose putting the non-bank lenders, who underwrote about three-fourths of the now-toxic sub-prime mortgages, under federal regulation. Non-bank lenders, the largest of which are now in bankruptcy, must follow federal principles that are enforced by states, which often lack the capacity to do so.
The group's recommendations don't offer help to homeowners who are struggling now, but they are an acknowledgement that federal regulators fell down on the job. In a speech detailing the recommendations, Treasury Secretary Henry Paulson said "market participants and regulators became complacent about all types of risks."
Many of the recommendations endorse efforts that the Federal Reserve already has undertaken to address shortcomings in mortgage lending. Others call for obvious improvements in performance, such as calling on the financial sector to evaluate risks better and for government regulators to talk to each other more.
"The Paulson strategy seems to be 'let the market work things out, with us as cheerleaders,' by and large," said Kurt Eggert, a law professor at Chapman University in Orange, Calif., and a former member of the Fed's Consumer Advisory Board. "That's what a significant portion of this plan is, scolding people and telling people they should do what they already should."
The working group — which includes the heads of the Treasury Department, the Federal Reserve, the Securities and Exchange Commission and other federal agencies — also proposed changes in how home loans are sold from one bank to another, then packaged in bulk into mortgage bonds.
This process, called securitization, is at the heart of today's turmoil on Wall Street. As home prices soared from 2001 to 2006, lending standards weakened, borrowers often overstated their incomes and some lenders didn't bother to verify borrowers' incomes. The resulting poor-quality loans were sold into the secondary mortgage market, where they were bundled with healthier loans and sold to investors as mortgage bonds, which now no investor wants.
The proposals call for the companies that issue mortgage bonds — called mortgage-backed securities — to disclose more information about how they've verified the loans that underlie the bonds being offered to investors. This, however, stops short of holding the purchasers in the secondary market accountable for the loans they're buying and bundling.
Only recently was the SEC granted powers to regulate credit-rating agencies, which certify the soundness of companies that issue mortgage bonds. Under Thursday's recommendations, the SEC will ask issuers of mortgage bonds to use different rating systems for the complex financial instruments that bundle loans into bonds. These ratings would differ from the ratings for conventional bonds.
This is important because many investors unwittingly bought mortgage bonds that they assumed carried the highest rating, only to find them all but worthless. In what amounts to sharp criticism of credit-rating agencies such as Standard & Poor's and Fitch, the presidential report calls on investors and managers of pension and mutual funds to do their own risk analyses, beyond the credit ratings.
At a technical briefing on the proposals, a senior SEC official said his commission was examining whether credit-rating agencies properly identified their inherent conflicts of interest. These agencies had one division that rated mortgage bonds for investors and another that served as a consultant when the complex bonds were being created by packaging sub-prime mortgages with other types of loans.
FBI investigators confirmed to McClatchy that they too are examining whether rating agencies followed their own rules and properly disclosed their potential conflicts of interest.
The panel's report was released on the same day that the chairmen of the House Financial Services Committee and the Senate Banking Committee together announced plans to introduce legislation to provide up to $300 billion in federal guarantees to help people who are in danger of losing their homes to foreclosure refinance into affordable mortgages.
The latest foreclosure readings from the Mortgage Bankers Association show that 1 in every 20 home loans nationwide is past due. The problem is most acute with adjustable-rate sub-prime loans, those given to borrowers with the weakest credit histories. One in 5 of these loans is delinquent.
Against that backdrop, Rep. Barney Frank, D-Mass., and Sen. Christopher Dodd, D-Conn., announced their plan to have the Federal Housing Administration insure at-risk loans that lenders have agreed to modify.
"We need to move aggressively . . . in order to regain our financial footing and ensure a crisis of this magnitude does not occur again," Dodd said.
The lawmakers hope to put a floor under the housing market, which has seen median home prices drop about 9 percent nationwide. Presidential candidate Sen. Barack Obama, D-Ill., issued a statement supporting their plan.
White House spokesman Tony Fratto said the Bush administration would review the proposed legislation but was loath to support any bailout.
"We're focused on policies directed at the homeowners and we've been clear in what we oppose: using taxpayer dollars to bail out lenders, investors and speculators," Fratto said.
Housing is the epicenter of today's economic problems. What started as isolated problems last year in a small but risky part of mortgage lending has snowballed into an avalanche crashing through the credit markets and affecting lending for everything from college tuition to corporate finance.
The Wall Street Journal published its regular survey of economic forecasters Thursday: Seventy-one percent said they thought that the U.S. economy was now in recession.
ON THE WEB
President's Working Group recommendations.
Proposed Fed rules for mortgage market.
A tougher view on market failures:
McClatchy 2007 story on weak enforcement.
McClatchy story on foreclosures.
McClatchy 2007 story on regulatory failure.
McClatchy Newspapers 2008