Geithner and Paulson say more regulation needed

Henry Paulson said Thursday there was no plan in place for the government to deal with a financial disaster when he became Treasury secretary in 2006 but that he worked to reduce potential risks as soon as he took office.

At the same time, Paulson cautioned against overreaching on financial overhaul legislation now before Congress that he said could stifle innovation in the markets.

Paulson testfied at a hearing of a special panel investigating the financial crisis and the so-called “shadow” banking system.

“There wasn’t a plan in place when I arrived,” he said, adding that the system of financial regulations was marked with big gaps as complex markets proliferated outside government oversight.

“I began immediately to work to mitigate risk,” he said at the hearing by the congressionally chartered Financial Crisis Inquiry Commission.

Addressing the market for so-called repurchase agreements, which banks depended on for massive daily loans from other financial companies — Paulson said no one had recognized its danger as it grew.

“It grew like topsy-turvy,” he said. “The system didn’t keep up, the infrastructure didn’t keep up … and the participants got sloppy in their credit decisions.”

Paulson also criticized Wall Street credit rating agencies that gave unrealistically high ratings to securities before the crisis. He said he supports legislation that would force them to disclose more and subject them to more scrutiny from reguluators.

Laws and regulations should no longer make specific references to ratings provided by Fitch, Moody’s and Standard & Poor’s, Paulson said.

“I don’t want the rating agencies to be held up as the font of all truth,” he said. He said investors should “do some thinking for themselves.”

Asked about the complex investments arranged by banks that have come under scrutiny and criticism as dangerous betting in the aftermath of the housing crisis, Paulson said “That business, I think, is a very beneficial business, a very legitimate business.”

But he said it must be conducted with high standards and integrity. For two years before he became Treasury secretary, Paulson headed Wall Street powerhouse Goldman Sachs, which sold to investors tens of billions of collateralized debt obligations — pools of securities tied to mortgages or other types of debt. The Securities and Exchange Commission has accused Goldman of civil fraud in connection with its disclosures to investors on one of the CDOs.

Paulson said he didn’t recall the specifics of the Goldman transactions.

Treasury Secretary Timothy Geithner, who was scheduled to appear later before the panel, says a root cause of the financial crisis was Congress’ failure to give regulators enough power to rein in risk-taking by financial firms operating outside traditional rules.

As president of the New York Federal Reserve in 2008, Geithner was one of the key architects of the government’s response to the crisis and the federal bailout.