By David Cho and Jeffrey H. Birnbaum
Washington Post Staff Writers
Friday, March 14, 2008
The nation's top economic policymakers unveiled a far-reaching plan yesterday to fortify the U.S. financial system, aiming to prevent a repeat of the credit meltdown that has roiled global markets since the summer.
The proposals call for changes to nearly every segment of the credit markets and mortgage industry, including the creation of national standards for mortgage brokers, tighter oversight of credit-rating firms and stricter capital requirements for financial institutions making risky investments. The plan's authors did not explain how they would translate their ideas into laws.
The continuing toll of upheaval in the credit markets was underscored yesterday when the government reported that consumers curtailed spending in February. The dollar fell to record lows against the euro and below 100 yen for the first time since 1995. Crude oil rose above $111 a barrel for the first time.
Meanwhile, a hedge fund run by District-based Carlyle Group defaulted on $16.6 billion in loans and teetered on the verge of collapse, raising concerns about failures at similar funds. Shares of Bear Stearns, the country's largest brokerage for hedge funds, hit a seven-year low and ended the day down 7.4 percent on concerns that it, too, could run short of money.
The toxic combination of news sent the Dow Jones industrial average and the Standard & Poor's 500-stock index down nearly 2 percent in the morning. Both indicators recovered to end the day slightly higher after a report from Standard & Poor's concluded that losses in subprime mortgages, which triggered the credit crisis, may be nearing an end.
Most economists say Wall Street's credit woes are tipping the country into recession. Treasury Secretary Henry M. Paulson Jr. acknowledged that yesterday's report from the President's Working Group on Financial Markets is not intended to immediately solve those problems. Instead, the effort is intended to gradually restore confidence in the financial system.
Many of the group's recommendations take aim at the mortgage securitization process, which for years was a highly profitable business that allowed Wall Street firms to collect big fees for turning home loans into securities and selling them to investors. The report wants rating agencies to be transparent about how they evaluate and score securities because these firms have so often been wrong in their ratings. It also chides lenders and big funds for becoming sloppy in their investment practices when markets were booming earlier this decade.
Taken in total, the effort seeks to cure three paramount failings behind the credit meltdown: Financial firms at each step of the securitization process didn't know what they were buying, didn't care as long as they were making money, and didn't have enough cash to cover mistaken bets.
Paulson remained vague, however, about what new standards should be established and who would oversee them. For example, he said legislation would be required to revamp the securitization process but declined to be more specific.
"It's clearly going to take a while to put these recommendations in place and to implement them," Paulson said in an interview. "We must implement these recommendations with an eye toward not creating a burden that exacerbates today's market stresses."
Industries addressed in the report, and some Wall Street banks, gave a cool reception to the proposals.
Christopher Low, chief economist at FTN Financial, said the recommendations would probably make the situation worse because tighter regulation and capital requirements could make financial firms even less willing to invest or make loans at a time when credit is already tight.
"Unfortunately, you've got the brightest minds of both parties working night and day to come up with solutions, and so far there have been a lot more misses than hits," he said.
The report was prepared by the government's most powerful regulators, including Paulson, who chairs the group; Federal Reserve Chairman Ben S. Bernanke; and Securities and Exchange Commission Chairman Christopher Cox. Before Paulson took office, the group, established by President Ronald Reagan, had hardly met.
After starting work seven months ago, those policymakers and the heads of several other federal agencies held two long meetings to craft a framework for their proposals, while top staff members regularly cloistered to hammer out the details. Paulson and Bernanke, in particular, worked closely together, spending half the day on a Saturday in early March to shape the final recommendations.
The high-level, interagency nature of the committee made it difficult for special interests to influence the group, though Paulson said he kept in contact with the private sector.
"It's not a group that's lobbied," said Edward L. Yingling, president of the American Bankers Association. "It meets very quietly on its own."
Because few outsiders participated in drafting the recommendations, the group has "a lot of work to do" to persuade private firms to agree to new policies, Paulson said. "When all of the regulators come together and speak with one voice, that's very powerful."
But if businesses such as credit-rating firms and mortgage brokers prove to be resistant to persuasion, Paulson warned, "We obviously will take the next steps . . . and if we need additional authorities, we'll go get them."
Leading credit-rating firms Moody's and Fitch Ratings did not comment on the recommendations, saying they would work with the group and appreciated its efforts.
The National Association of Mortgage Brokers was less receptive. "Regrettably, we were not asked to provide input into the recommendations," said Executive Vice President Roy DeLoach. "We believe it is a flawed plan to ask regulators of state lenders and mortgage brokers for greater oversight without including all lenders."
Paulson, a former chief executive of Goldman Sachs, also raised the hackles of some Wall Street bankers by suggesting they cut dividends to shareholders to raise their capital levels to cover potential losses. They said punishing shareholders was the wrong move for banks that are struggling.
Staff writers Tomoeh Murakami Tse in New York and Neil Irwin contributed to this report.