Treasury Secretary Henry Paulson unloaded a doozy on the financial and mortgage markets Monday morning, suggesting sweeping reform to the broader financial system -- and, in particular, suggesting massive changes to the regulatory framework for mortgage banking. The recommendations come on the heels of an unprecedented bailout of Bear Stearns, and historic market liquidity measures taken in the past few weeks. The changes are the largest proposal yet by officials looking to deal with the fallout from a massive mortgage and housing crisis that has shaken the U.S. financial system to its core. "We should and can have a structure that is designed for the world we live in, one that is more flexible, one that can better adapt to change, one that will allow us to more effectively deal with inevitable market disruptions and one that will better protect investors and consumers," said Secretary Paulson in remarks at the Treasury Department. "The challenge is to evolve to a more flexible, efficient and effective regulatory framework – and that is the purpose of this blueprint." A Federal watchdog for brokers The plan outlines both short and longer-term proposals for reform; the short-term recommendations include a proposal to establish a Federally-funded Mortgage Origination Commission, a new agency responsible for evaluating, rating, and reporting on the adequacy of each state’s system for licensing and regulating "participants in the mortgage origination process." The language clearly targets mortgage brokers, who many have argued contributed signficantly to the mortgage mess. "We are recommending retaining state-level regulation of mortgage origination practices, but we are also recommending creating a new federal-level commission," Paulson said in a press conference Monday morning.   "Legislation should either set forth or task this Commission to establish minimum standards which should include personal conduct and disciplinary history, minimum educational requirements, testing criteria and procedures, and appropriate license revocation standards." Beyond regulation, Paulson said the new agency would publicly rate states on their compliance with the agency's standards, a move that he suggested would help secondary market participants better price risks in securitization. "These evaluations could provide further information regarding whether mortgages originated in a state should be viewed cautiously before being securitized," he said. A new, streamlined mortgage world Longer-term, Paulson proposed merging the Office of Thrift Supervision and the Office of the Comptroller of the Currency, saying that thrift charters have become obsolete and that he wanted to migrate national banks to a common bank charter. "The thrift charter is no longer necessary to ensure sufficient residential mortgage loans availability for US consumers," Paulson said. "In the blueprint, we have concluded that the thrift charter has run its course and should be phased out. With the elimination of the federal thrift charter, the OTS would be closed and its operations would be assumed by the OCC." Paulson's remarks may indirectly be criticism of how some of the nation's larger mortgage lenders have used a thrift charter to shield their operations and push risk towards the Federal banking system, some sources told HW. Countrywide, in particular, recently moved all of its mortgage lending activity within its thrift. The proposal also contrasts with earlier remarks by OTS Director John Reich, who in September had stumped for his agency to oversee of Wall Street mortgage banks. Instead, reponsibility for that level of oversight would go to the Federal Reserve under Paulson's plan. At the state level, the plan calls for "rationalization of direct federal supervision of state-chartered banks," and suggests a study be commissioned to streamline regulation. The OTS isn't the only agency that would be streamline, however, under the blueprint. Paulson also proposed that the Securities and Exchange Commission and the Commodity Futures Trading Commission be combined into a single market-watching body. He also proposed a significant widening of the responsibility of the Federal Reserve as well, giving the central bank "a different, yet critically important regulatory role and broad powers focusing on the overall financial system," the executive summary said, including regulator powers over Wall Street investment banks. The result of the blueprint would be to establish three distinct regulators that would focus exclusively on financial institutions: a market stability regulator, the Fed; a new prudential financial regulator, combining the OCC, OTS and NCUA; and a new business conduct regulator, combining the CFTC and SEC, and some roles of bank regulators. Reaction focuses on Fed's role Much of the market reaction thus far has centered on the broadly expanded powers for the Fed under the proposal. Via the Wall Street Journal:
"Supervising the very complex derivative products of the banks and of the rest of the financial system would be an enormous technical challenge," said Harvard University economist Martin Feldstein, a prominent Republican adviser who has criticized the Fed's supervision of banks leading up to the current crisis. "The institutions themselves -- paying very high salaries and having their own survival at risk -- got it wrong. Would the Fed get it right?"
In his remarks Monday, Paulson seemed to expect debate and disagreement, and acknowledged that reform would likely take years. "This will not be a small or easy effort – transformative efforts rarely are," he said. "But this is a subject we must debate, and ultimately address, for our long-term economic growth and prosperity." Congressional leaders welcomed the the proposal as a signal of change in direction from the Bush administration, even if few had yet had a chance to digest the most sweeping financial reform proposal since the Great Depression by the time this story was published. "We have not yet analyzed the proposals in detail, and I have disagreements with some specifics—e.g. the plan goes too far in diminishing the role of the states, and not far enough in conferring needed new powers on the Federal Reserve over non-bank financial institutions for which they now have greater responsibility," said Rep. Barney Frank, chairman of the House Committee on Financial Services. A greater push for a mortgage bailout isn't likely to be far behind, as a result, say some sources. "Paulson's come out and said the financial system is broken, essentially," said one source, who asked not to be named. "It's not much further for the Democrats to say that borrowers were the victims of a system in need of reform -- and trust me, they'll be saying it soon enough." While the particulars are unknown, and vehement discussion on both side of the borrower bailout debate will continue, one thing is clearer than ever: the mortgage industry is about to be regulated in ways many probably never thought possible, even one year earlier.