Paulson Cracks Whip at Mortgage Industry

Treasury Secretary Hank Paulson announced a series of new regulations on Thursday aimed at restoring faith in securities markets, which have been rocked by a colossal blow-up in mortgage-related financial products amid the deepening housing slump.

The proposals, developed by the President's Working Group on Financial Markets, mirror those that have been repeatedly put forth by Democrats in Congress during the past year, as the nation struggles to overcome the steepest declines in residential real estate since the Great Depression.

"This effort is not about finding excuses and scapegoats," said Paulson at a press conference. "Poor judgments and poor market practices have led to mistakes by all participants [in the markets]."

For mortgage brokers, Paulson recommended a set of nationwide licensing standards.

For credit ratings agencies like Moody's Investors Service and Standard & Poor's, Paulson proposed new disclosure requirements about potential conflicts of interest, and he wants the firms to differentiate between ratings on complex structured products and conventional bonds.

Paulson also said issuers of mortgage-backed securities should be required to disclose if they have shopped around to different ratings agencies for a favorable rating.

Billions of dollars in writedowns on mortgage-related investments by major investment banks like Citigroup (C Quote) and Merrill Lynch (MER Quote), as well as government-sponsored mortgage giants like Fannie Mae (FNM Quote) and Freddie Mac (FRE Quote), have provoked a mass loss of faith in the validity of credit ratings in the market.

The prime example of this is the recent collapse in stock prices for bond insurers like MBIA(MBI Quote) and Ambac Financial(ABK Quote). Both firms, which are major clients of the credit ratings agencies, underwrote insurance policies on billions of dollars in structured finance securities aimed at boosting credit ratings. Now, investors are questioning whether the firms have enough capital to justify their own triple-A ratings and their ability to pay the claims that are in store.

Paulson also repeated his call for financial institutions to raise more capital and to revisit their dividend policies.

Wall Street analysts have predicted hundreds of billions in more writedowns on mortgage-related investments. Nouriel Roubini, founder and chairman of RGE Monitor and an economics professor at New York University, says the losses will likely go into the trillions.

"There is no significant recognition in the markets yet that things are getting very bad and they're going to get worse," says Roubini, who was an early predictor of the housing bust.

The President's Working Group on Financial Markets includes representatives from the Federal Reserve, the Securities & Exchange Commission and other federal regulatory institutions. Paulson said the group's proposals can be enacted without new legislation from Congress, and he expects regulators to adopt the rules.

"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," Paulson said.