Regulators unveil plan to revamp mortgage rules

WASHINGTON (Reuters) - Financial regulators pledged on Thursday to toughen rules for mortgage brokers, lenders, and credit agencies, to try to restore investor confidence and prevent a recurrence of credit-market problems that threaten to slow the economy.

U.S. Treasury Secretary Henry Paulson, unveiling a 20-page set of recommendations from the top-level President's Working Group on Financial Markets, blamed a "dramatic weakening" of underwriting standards for lower-quality home loans that have trigged turmoil in credit markets around the globe.

Paulson, a Wall Street veteran who took the reins at Treasury in mid-2006, said "financial innovation", like the practice of slicing up and repackaging so-called subprime mortgages for sale worldwide, had worsened the situation by introducing a baffling level of complexity.

Speaking at the National Press Club in Washington D.C., Paulson appealed to banks and other lenders not to stop issuing the loans that are the lifeblood of the economy and implied they should reduce dividends paid to shareholders if necessary to raise capital.

"We are encouraging financial institutions to continue to strengthen balance sheets by raising capital and revisiting dividend policies; we need those institutions to continue to lend and facilitate economic growth," he said.

Among other items, the regulators recommended "strong nationwide licensing standards" for mortgage brokers, stiffer federal and state oversight of all mortgage originators, and new rules to force more disclosure of loan terms to borrowers.

Analysts said the proposed changes, which touch nearly every corner of the credit market, from Wall Street firms to credit rating agencies to regulators, come too late to forestall a wave of foreclosures sweeping the country. Some suggested brokers in particular needed more scrutiny.

"Mortgage brokers need to have some skin in the game, so that if they defraud borrowers, the brokers are worth suing," said Kurt Eggert, a law professor at Chapman University in Orange, California.

REGULATORS LEFT BEHIND

The regulatory working group is made up of the heads of the Federal Reserve Board, the New York Federal Reserve, the Securities and Exchange Commission, and the Commodity Futures Trading Commission, as well as Treasury officials, and Paulson said it had focused since last summer on finding ways to reduce the likelihood of a repeat performance in the U.S. mortgage market.

"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," he said.

Chris Low, an economist with FTN Financial Capital Markets, said in the short run the recommendations, if implemented, could make it harder for people with marginal credit to refinance existing mortgages and so worsen the situation.

But, he added, more regulation is inevitable and if President Bush's administration doesn't act, the U.S. Congress likely will.

Democratic Sen. Charles Schumer of New York said he believed direct government involvement eventually will be needed to help the economy, and said the proposals seemed like a first, tentative step in that direction.

"We need government action not only to solve the current crisis, but also to prevent a future one," he said.

Many Democrats advocate a bolder federal response. House of Representatives'' Financial Services Committee Chairman Barney Frank unveiled a bill on Thursday that would allow the Federal Housing Administration to offer guarantees for mortgages whose values have been written down.

SLOPPY LENDING

Paulson said state and local regulators need to toughen oversight of all mortgage originators.

Sloppy lending practices are widely blamed for the soaring tide of foreclosures. U.S. foreclosure filings in February stood 60 percent higher than their level a year-ago, real estate data firm RealtyTrac said on Thursday.

Paulson also said credit rating agencies need to make sure that securitized credit issuers, like those who issue mortgage-backed securities, "perform robust due diligence" to ensure that the underlying assets are sound.

"We are going to be mindful when we implement it to not create a burden," Paulson said in an interview published in the Wall Street Journal on Thursday. "But we think it's very appropriate to lay out some of the causes and some of the steps that need to be taken ... to minimize the likelihood of this happening again."

(Additional reporting by David Lawder and Kevin Drawbaugh in Washington and Ritsuko Ando in New York)