The Treasury Secretary's policy recommendations do little to solve the current crisis, but they may have reassured investors
Call it an attempt to lock the barn door before the next group of horses escapes. Even as criticism has mounted that the Bush Administration has moved too slowly to stem the slide in housing and credit markets, Treasury Secretary Henry Paulson on Mar. 13 announced a series of recommendations intended to prevent a recurrence of the lapses and errors that led to the meltdown in the first place.
"As we continue to address the current market stress, we must also examine the appropriate policy responses," Paulson said in a speech at the National Press Club in Washington. But he also sounded a note of caution aimed at heading off calls for more radical regulatory changes emanating from Congress, consumer groups, and others critical of the financial industry.
Calming Market Jitters
"The objective here is to get the balance right," said Paulson. "Regulation needs to catch up with innovation and help restore investor confidence, but not go so far as to create new problems, make our markets less efficient, or cut off credit to those who need it."
Analysts say the timing of the speech was also meant to help steady rattled markets. Growing evidence that the U.S. economy is in recession and accelerating liquidity problems have heightened fears that the housing and credit markets shows no signs of bottoming out. "One of the most significant things about the proposal was the fact that they rushed it out," says Karen Petrou, managing partner of Federal Financial Analytics, a Washington (D.C.) consultant to the financial-services industry. "As recently as last week, the Administration's view was that it better to continue to consider these issues more slowly." But with the markets clearly spooked, she adds, officials decided to speed up the release of the proposals.
The announcement may have helped calm things a bit. Stocks began the day in the U.S. in a tailspin, then bounced back. The Dow Jones industrial average finished Mar. 13 up 35.5 points, or 0.29%, to 12,145.74. The broader Standard & Poor's 500-stock index gained 6.71 points, or 0.51%, to 1,315.48.
But Paulson's plan also raised new questions. Despite his caution, some complained that the forward-looking nature of the recommendations do nothing to address the current woes, even as they risk further tightening conditions in the mortgage and securities markets. "Is now the right time to make it more difficult to obtain loans?" asks one former Treasury Dept. official who now represents a financial-services industry trade group in Washington. "Increasing regulatory scrutiny is no doubt a prudent measure, but right now, it's putting the cart before the horse. It's not in the best interest of improving short-term liquidity in the markets and doesn't do anything to correct the fundamental problem, which is banks' unwillingness to lend."
PWG Fingers All Players
The list of recommendations comes after months of work by the President's Working Group on Capital Markets, or PWG. Led by the Treasury Dept., the group also includes the heads of the Federal Reserve Board, the Securities & Exchange Commission, the Federal Reserve Bank of New York, and the Commodity Futures Trading Commission.
If the goal of the PWG was to develop policy responses to head off a similar crisis in the future, the proposals that Paulson announced also reflect a tacit admission of the failure of all players involved in the current crisis: mortgage lenders and brokers, investors, securitizers, credit ratings agencies, and the regulators themselves. And in their suggested changes, the PWG offered something for everyone.
Start with mortgage brokers, whose lax lending practices in recent years have been at the core of the housing problem. Paulson called for a national, federally run system for licensing mortgage brokers.
To address the problems that have arisen with ratings of mortgage-backed securities—many of the securities have proven to be nowhere near as credit-worthy as their ratings imply—the PWG is advocating that ratings agencies boost disclosure about potential conflicts of interest and how they manage them. These can arise because bond issuers generally pay the agencies to rate their products.
Ratings Agencies Oversight
Paulson also called on the ratings agencies, such as Moody's Investors Service (MCO) and Standard & Poor's (which, like BusinessWeek, is owned by The McGraw-Hill Companies (MHP)),to more clearly differentiate between ratings given to structured products, such as securitized pools of mortgage-backed securities, and those given to more traditional corporate or municipal bonds. And he argued that the agencies need to do a better job of ensuring that the issuers of securitized debt are doing robust due diligence on the firms that originate the assets pooled in such securities.
That should help, though it's a far more limited change to the ratings agencies' business model than some have called for. Critics have argued that investors should pay for ratings agency research, rather than issuers. But such a change is unlikely, and improving disclosure along with due diligence and other processes within the agencies may be as far as regulators can go. "Given the limited regulatory control they have over the ratings agencies, they are very limited in what they can do," says Daniel Clifton, Washington policy analyst for investment firm Strategas Research. "The way I read this, the recommendation is intended to make the industry and ratings users put the pressure on the agencies."
