U.S. Rep. Barney Frank calls for the creation of a new financial services risk regulator while addressing the Boston Chamber of Commerce last week.

With his proposal to create a brand-new financial services risk regulator as a solution to the widening subprime mortgage crisis, U.S. Congressman Barney Frank has set out a major policy agenda item for next year, one local observer said.

“Frank is clearly setting the table for the next Congress,” said Cornelius K. Hurley, director of Boston University’s Morin Center for Banking and Financial Law.

The new post or agency, which Frank announced during remarks to the Greater Boston Chamber of Commerce on March 20, would supervise any entity that creates credit, including non-depository institutions such as investment banks, which are not subject to the same safety and soundness rules governing other banks.

The regulator would have the power to “receive timely information from market players, inspect institutions, report to Congress on the health of the entire financial sector and act when necessary to limit risky practices,” according to a House Financial Services Committee summary of the plan.

Frank said deregulation was the watchword when he took over as chairman of the Financial Services Committee in November 2006. But time has shown “more damage was done by inadequate regulation than by too much,” he said.

The Bush administration also is considering its own regulatory restructuring proposal, Hurley said, but that administration is outgoing, while Frank is expected to remain as Financial Services Committee chairman next year. Frank’s plan, therefore, is likely to get the lion’s share of attention.

Frank, a Massachusetts Democrat, said close to 3 million foreclosures are expected nationally in 2008. In a “normal” year, roughly 600,000 foreclosures are filed, he said.

Frank said more people are defaulting on subprime mortgage loans because neither non-bank mortgage companies and brokers nor the Wall Street investors who bought the mortgages had incentives to ensure they would be paid back.

The U.S. economy is in recession because of the subprime mortgage crisis and resulting credit crunch, he said. Because mortgages have been securitized and sold worldwide, the problem has spread beyond U.S. borders.

“Our major export to Europe in the past year has been bad mortgages,” he said, tongue-in-cheek, referring to governments and banks that purchased subprime mortgage-backed securities that aren’t performing.

It is not yet clear whether depository banks – which already are regulated for safety and soundness by one of four federal agencies – would be subject to the supervision of a financial services risk regulator. Fannie Mae, Freddie Mac and the Federal Home Loan Bank have their own, separate regulators.

But Frank said he wants to look at extending regulations that have already kept traditional banks largely out of the subprime fray.

“If banks had made the subprime loans, we would not have this crisis,” he said.

Government Stake

Daniel J. Forte, president of the Massachusetts Bankers Association, said banks are required by safety and soundness regulations to make sure the loans they make can be repaid.

“One of the key points we’ve been trying to make is that there is a difference” between banks and non-bank brokers and lenders, he said. “Banks need to insure that they’ll get paid back.”

Regulations that will give non-banks and securitizers more of a financial stake in whether the loans they make are paid back are both necessary and good for the market, Frank said.

Most investment banks are subject to oversight from the Securities and Exchange Commission, whose main job is to ensure that potential investors get adequate information and disclosures. Investors use the information to determine for themselves if the investments are sound.

Hurley said that last week’s decision by the Federal Reserve to open, for the first time, its discount window to major investment banks needing financial liquidity, may have been a catalyst for Frank’s proposal.

“I think the bell that went off with Barney Frank was, ‘hey, the taxpayers now have a big stake in this, because the Fed has opened up the discount window,'” he said.

The so-called discount window, which lends profits from the Federal Reserve’s earnings on its own investments in government bonds to borrowers, normally is open only to commercial banks needing emergency financial liquidity, Hurley said. Whatever money banks don’t borrow is transferred to federal government coffers.

The government has a greater risk of losing money loaned to an investment bank not regulated for safety and soundness, he explained.

“With the risk shifted from the investment bank to the Fed, the government has more of a stake and there needs to be more oversight.”

Frank also called for quick action on legislation he filed on March 13 that would provide $10 billion in loans to states to address the foreclosure crisis by expanding the Federal Housing Administration loan program to offer guarantees to refinance at-risk borrowers into viable mortgages.

He urged mortgage lenders to allow FHA to refinance such loans if they involve owner-occupied principal residences.

This would require lenders to reduce the mortgage principle “substantially” to a level the borrower can repay more easily, he said.

In exchange for the write-down, the lender or mortgage holder would receive payment from the proceeds of a new FHA loan if the restructured loan would result in terms the borrower could reasonably be expected to repay.

That would be better financially for lenders than foreclosing on all properties currently in default, he said.

Scott DeFife, senior managing director for government affairs at the Securities Industry and Financial Markets Association, a New York-based industry trade group, said the organization “welcomes Chairman Frank’s call for a comprehensive review of the regulatory framework for financial markets, including his call for consolidating the duplicative regulatory structure.

“Recent events have made it critically clear that we must focus on both the evolution and innovation in the financial markets to help reduce the current turmoil,” DeFife said.