US Treasury Secretary Henry Paulson said US regulators plan to alter rules for packaging loans into bonds in the aftermath of the subprime-credit collapse.
Paulson and Federal Reserve Chairman Ben Bernanke, who were to testify before Congress yesterday, first want markets to stabilize, reducing borrowing costs for companies and consumers. Policymakers are trying to revive an economy that expanded at the slowest pace since 2002 last year.
Paulson, Bernanke and their counterparts at the Securities & Exchange Commission and Commodity Futures Trading Commission (CFTC) are "carefully" reviewing loan securitizations, the treasury chief said on Wednesday.
The process magnified losses on subprime mortgage-linked securities because it reduced the incentive for lenders to ensure that borrowers could repay their debts.
"You can't have gone through the process we've gone through without knowing there need to be some changes," Paulson, 61, said in an interview with Bloomberg Television on Wednesday in Washington. "First, we need to get through this period with as little impact as possible on our economy. And then secondly, we need a strong policy response."
Paulson, Bernanke and SEC Chairman Christopher Cox were to testify before the Senate Banking Committee on the economy and financial markets.
Democratic Senator Christopher Dodd, who chairs the banking committee, introduced legislation in December to curb predatory-mortgage lending. His bill includes a provision to hold mortgage-bond investors responsible for loans that violate the law.
Similar legislation passed by the House in November would hold companies that sell mortgage-backed securities responsible for bad loans. Dodd said last year that regulators had "flexibility" to make investors accountable.
Paulson predicted it would be "a number of months" before the four-member President's Working Group on Financial Markets announces its recommendations on securitized loans. The group, which advises the White House, consists of Paulson, Bernanke, Cox and CFTC Chairman Walter Lukken.
"The problem is so large it's going to be difficult to force any large-scale changes," said Joe Mason, an associate professor of finance at Drexel University in Philadelphia. "You need to think about how financial innovation takes place in this economy."
Banks and securities firms have amassed more than US$146 billion in losses after a surge in subprime mortgage defaults rippled through markets.
Most subprime mortgages were packaged into bonds. Those securities were then often repackaged into investments known as collateralized debt obligations.
Many of the securities were given top credit ratings by Moody's Investors Service, Standard & Poor's and Fitch Ratings, reducing the incentive for investors to research the asset quality of the underlying loans.
"We're looking at off-balance-sheet contingent liabilities ... We're looking at accounting and valuation issues. We're looking at the rating agencies," Paulson said.
The SEC last week said it may propose rules requiring credit-rating companies to tell investors how successful their past assessments of debt quality have been.
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