SEC proposes tighter rules on securities that helped fuel financial crisis

By Zachary A. Goldfarb
Washington Post Staff Writer
Thursday, April 8, 2010

Federal regulators unveiled stricter rules Wednesday for a key source of funding for home, auto and credit-card loans that has been blamed for worsening the financial crisis by allowing trillions of dollars in risky investments to be sold around the world.

The Securities and Exchange Commission proposed that banks share the risk of losses when issuing asset-backed securities, which are created from bundles of loans and sold to investors. It also proposed far more disclosure about the loans making up those investments, whose contents are seldom reviewed by investors.

The measures are designed to alleviate concerns that banks, looking to generate fees, bundled subprime and other risky mortgages into investments and sold them without considering whether the underlying loans would go bad.

That bundling process, called securitization, grew rapidly in the years ahead of the financial crisis. But the market for securitized loans broke down after the 2008 financial meltdown, in which many of the investments unexpectedly soured, causing more than $1 trillion in losses. The SEC proposals come as the securitization market is roaring back, with more than $30 billion in repackaged loans this year -- more than double the amount for all of last year.

At a meeting Wednesday, SEC Chairman Mary Schapiro called the proposals a "fundamental revision" to how securitization is regulated and said the "changes are both necessary and critical components of restoring investor confidence." All five of the agency's commissioners voted for the proposals, which now are subject to 90 days of public comment before the agency takes final action.

Although the agency doesn't have the authority to tell lenders what kinds of loans to make, experts said the measures are intended pressure firms to make better loans. "I think what it will do is bring discipline and integrity to the underwriting process ," said Laura Unger, an adviser to Promontory Financial Group and a former SEC commissioner. "By virtue of the transparency about the loans in the pool, the issuers will be forced to actually have a better quality of assets."

One proposed rule would obligate banks and other financial firms that securitize loans to own 5 percent of the securities they sell. That "skin-in-the-game" requirement has provoked intense debate.

Supporters say the rule would align the interests of banks and investors by putting banks on the line for potential losses. Critics, however, say many banks, even though they were not required to do so, invested in the same types of risky securities that they sold to investors in the years before the crisis.

Another proposed rule would for the first time require banks to release more detailed data on the loans in asset-backed securities so investors can make more-informed decisions about whether to buy them.

This step, among others, would reduce reliance on the credit-rating firms that assess the quality of securitized loans. These firms have historically played a central role in securitization, but critics blamed them for giving investors a false of confidence in securities that turned out to be dangerous.

The SEC proposals would exempt a significant slice of the securitization market from ownership requirements: private securities that are marketed to small groups of investors.

But those private securities would still be expected to meet a host of regulatory capital and accounting standards. Those requirements could raise costs and "could significantly reduce the availability and affordability of private lending to consumers and small businesses over time," said Tom Deutsch, executive director of the American Securitization Forum, a trade group.

That concern is playing out in mortgage securities. The government is now funding 90 percent of mortgages after the private market collapsed during the financial crisis, but policymakers hope to get private lenders back into the business.

The SEC, however, said the proposed rules "may give a competitive advantage to residential mortgage originators who can securitize through government-sponsored enterprises and may increase the cost of non-conforming loans to borrowers."

Experts said the new measures could help prevent the problems that fueled the financial crisis. But some are skeptical that additional disclosure and requirements that banks own some of the securitized loans would overcome an economic bubble.

"I think it would have helped, but it wouldn't be major because the major problem was the explosion of the bubble in housing and that overwhelms all other causes," said Hal Scott, a law professor at Harvard and regulation expert. "This is not bubble prevention. This is operating at a much more micro level."

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