Remarks by Treasury Secretary Paulson

(page 3 of 5)

This will require reforming structured credit product rating processes to ensure integrity and transparency, and improving the quality of data, models, and assumptions. Credit rating agencies must enforce policies and procedures that manage and disclose conflicts of interest, and implement changes suggested by the SEC review of conflict of interest issues.

The credit rating process needs to clearly differentiate between structured products ratings and ratings for corporate and municipal securities. And agencies should require securitized credit issuers to perform robust due diligence of originators of assets that are securitized or used as collateral for structured credit products.

The PWG will form a private-sector committee to work toward implementation of these rating agency recommendations and develop additional ones, as needed. The PWG member agencies will reinforce credit rating agencies' efforts through revisions to supervisory policy and regulation, and revisit the need for stronger oversight if the industry-led reforms do not lead to the integrity and transparency we seek. Regulators must also review how they encourage the use of ratings in rules and guidance; at a minimum, regulatory policies should distinguish between structured credits and corporate and municipal bonds.

Securitization

The securitization of a number of credit products, including residential and commercial mortgages, credit card receivables, student loans and business loans have brought us greater availability and lower cost credit. This has been positive for our economy. But with innovation in securitization and structured credit products has come varying degrees of complexity and other challenges, particularly related to securitization of mortgages.

For illustrative purposes, I will describe how the PWG recommendations will impact mortgage securitization. But first a few words about the process.

Mortgage brokers shop home loan applications to financial institutions and other lenders. Lenders then originate the mortgage loan and provide funds so the borrower can buy a home. The next step is securitization, packaging mortgage loans into securities. The originators sell these loans to securitizers that pool them with other loans into mortgage-backed securities (MBS). The MBS can be pooled again into collateralized debt obligations (CDOs), and multiple CDOs can be pooled further into what are called a "CDO Squared." Along the way, the mortgage loans can also be sliced into tranches representing different cash flows and payment risks.

The PWG has determined that there is no single, simple solution to the problems that have emerged from the mortgage securitization process, yet we have determined that market participants' behavior must change. I expect that market participants and regulators will implement these recommendations; when they do, we will see changes at every step of the securitization process:

Mortgage Brokers will be held to strong national licensing and enforcement standards. There will be stricter safeguards against fraud, and full and clear disclosure to borrowers about home loan terms, including long-term affordability.

Credit Rating Agencies will clearly differentiate structured product ratings from ratings for corporate and municipal securities. They will also disclose reviews performed on asset originators, and strengthen data integrity, models and assumptions.

Issuers of Mortgage-Backed Securities will disclose the level and scope of due diligence performed on underlying assets, disclose more granular information regarding underlying credits. And, if issuers have shopped for ratings, disclose the what and why of that as well.

Investors will conduct more independent analysis and be less reliant on ratings. They will require, receive and use more information and more clearly differentiate between structured credits and corporate and municipal securities.

These practices will better align the interests of mortgage originators and homebuyers, of originators and securitizers, of securitizers and rating agencies and, ultimately, investors.

Regulators have a role to play in every change.