The March 13 report of the President’s Working Group on Financial Markets is a good start towards preventing another credit crisis like the one that has been shaking up Wall Street for the last several months. Rather than trying to clean up the current mess or assigning blame, the report seeks to prevent future crises of this type.
The good news is that unlike many of the plans that have been floating around Capitol Hill, the report’s proposals seek to supervise and monitor the credit markets rather than to micro-manage them with a series of new heavy handed laws. The emphasis is on transparency and disclosure.
In particular, the report calls for improvements by the credit rating agencies which ‘grade’ securities when they are issued. Currently, both traditional securities and structured securities, which consist of pieces of financial instruments such a mortgages, are graded the same way. The report would have the ratings agencies scrutinize the originators of the securitized assets to ensure that potential purchasers better understand what they are buying.
One factor in the current upheaval is that mortgages were made to home buyers who normally would not qualify for them, and then presented to buyers as being much higher quality than they actually were. That is why the report recommends better underwriting standards by originators of mortgages. A key recommendation is for states and federal regulators to better oversee mortgage brokers, including state licensing of those mortgage brokers who are currently unsupervised. License requirements would help to improve the quality of the mortgages those brokers create.
Among other recommendations are improved risk management by financial institutions, and better capital and disclosure requirements.
However, since the report is nothing more than a series of general guidelines and statements, how its recommendations are implemented will be extremely important. While most of its recommendations can be put into effect under existing laws, it will be important to watch carefully for congressional attempts to use its recommendations to justify harsh new laws that could end up crippling credit markets.