(Reuters) - A congressional panel blamed lax lenders cozy with regulators, credit raters, and devious behavior by investment banks in a report on the causes of the financial crisis released on Wednesday.
The 635-page bipartisan report from the Senate’s Permanent Subcommittee Investigations made the following 19 recommendations to avoid a repeat of the events that dragged the economy into recession from 2007 to 2008.
LENDERS: 1. Ensure “qualified mortgages” are low risk. Federal regulators should use their authority to ensure all mortgages deemed to be “qualified residential mortgages” have a low risk of delinquency or default.
2. Require meaningful risk retention. Regulators should issue a strong risk retention requirement, mandating retention of at least a 5 percent credit risk in each, or a representative sample of, an asset-backed securitization’s tranches. It should also ban a hedging offset for a reasonable but limited period of time.
3. Safeguard against high-risk products. Banking regulators should mandate that banks with high-risk structured products, including products with little or no reliable performance data, meet stricter loss reserve, liquidity, and capital requirements.
4. Require greater reserves for negative amortization loans. Banking regulators should use their power to require banks issuing these loans that allow borrowers to defer payments of interest and principal to maintain more conservative loss, liquidity and capital reserves.
5. Safeguard bank investment portfolios. Federal banking regulators should use a study required by the Dodd-Frank financial overhaul law to identify high-risk structured products and impose a reasonable limit on the amount of these that can be included in a bank’s investment portfolio.
BANKING REGULATION: 1. Completely dismantle the Office of Thrift Supervision. The Dodd-Frank law eliminated OTS, some of which was subsumed into the Office of the Comptroller of the Currency (OCC), another banking regulator. The report recommends against any preservation of the OTS’s influence within the OCC.
2. Strengthen enforcement. Federal banking regulators should conduct a review of their big financial institutions to identify those with major deficiencies, review their enforcement strategy to eliminate any policy of deference to bank management, inflated ratings, or use of short-term profits to excuse risky activities.
3. Strengthen ratings given to banks by regulators, known as CAMELS. Banking regulators should review the ratings system to ensure banks operate in a safe and sound manner over a specified period of time, and look at long-term risks, among other factors.
4. Evaluate high-risk lending impacts. The Financial Stability Oversight Council should study high-risk lending practices at financial institutions, and evaluate the impacts on the U.S. financial system.
RATING AGENCIES: 1. Rank credit rating agencies (CRA) by accuracy. The Securities and Exchange Commission should use its authority to rank the Nationally Recognized Statistical Rating Organizations in terms of performance, including accuracy of their ratings.
2. Help investors hold CRAs accountable. The SEC should use its regulatory power to help investors hold credit rating agencies accountable in civil lawsuits for inflated credit ratings.
3. Strengthen CRA Operations. The SEC should use its power to ensure credit rating agencies impose internal controls, credit rating methodologies, and employee conflict of interest safeguards to promote rating accuracy.
4. Ensure CRAs recognize risk. The SEC should ensure credit rating agencies assign higher risk to financial instruments whose performance cannot be reliably predicted, or that rely on assets from parties with a record for issuing poor quality assets.
5. Strengthen disclosure. The SEC should use its authority to ensure that credit rating agencies complete required new ratings forms by the end of the year and that the new forms provide useful ratings information to investors.
6. Reduce ratings reliance. Federal regulators should reduce the federal government’s reliance on privately issued credit ratings.
INVESTMENT BANKS: 1. Review structured finance transactions. Federal regulators should review the structured finance product activities described in the report to identify any violations of law and examine ways to strengthen existing regulatory prohibitions against abusive practices.
2. Narrow proprietary trading exceptions. To ensure a meaningful ban on proprietary trading, any exceptions such as for market-making or risk-mitigating hedging activities, should be strictly limited in the implementing regulations to activities that serve clients or reduce risk.
3. Design strong conflict of interest prohibitions. Regulators implementing these prohibitions consider the types of conflicts of interest in the Goldman Sachs case study.
4. Study bank use of structured finance. Banking regulators should consider the role of federally insured banks in designing, marketing, and investing in structured finance products with risks that cannot be reliably measured and naked credit default swaps or synthetic financial instruments.
Editing by Richard Chang