SEC seeks tighter rules on asset-backed securities

WASHINGTON — Federal regulators proposed new, stricter rules today for asset-backed securities, the bundles of loans that helped spark the market’s collapse in 2008 and nearly brought down the financial system.

The Securities and Exchange Commission voted 5-0 to propose that Wall Street firms that package and sell asset-backed securities be required in most cases to hold at least 5 percent of the packaged loans — mortgages, credit cards, auto loans — on their own books.

With some “skin in the game,” the thinking goes, the firms would be more careful to ensure that borrowers are properly screened.

Experts say it was the lack of “skin” that enabled a system in which bundles of mortgage loans were whisked from investor to investor, with no one assuming responsibility for the risk until the roof caved in.

Mortgage-backed securities were the pyramid of cards that collapsed and nearly blew up the financial system, bringing on the recession.

The government stepped in after the subprime mortgage disaster turned home loans that had been bundled together as securities into toxic assets. The Federal Reserve spent $1.25 trillion to buy up mortgage securities, a government support that ended last month.

The SEC’s proposed rules could be formally adopted sometime after a 90-day public comment period, possibly with changes.

The 5-percent minimum holding requirement would be a condition for firms seeking expedited SEC approval of their offerings of asset-backed securities for sale to investors. That process, known as “shelf” registration, is predominantly used by securities issuers. At the same time, an investment-grade rating from credit ratings agencies such as Moody’s Investors Service, Standard &Poor’s or Fitch Ratings would no longer be required for expedited approval.

Although the vote by the five SEC commissioners was unanimous, two of them — Republicans Kathleen Casey and Troy Paredes — voiced concerns about the new requirement for risk-holding. Paredes said it may not make sense to apply a 5 percent minimum requirement to every offering of asset-backed securities.

The SEC’s proposal also would require the firms to provide fuller disclosures on asset-backed securities.

The disclosures would include information on every underlying loan in a package. For example: What type of mortgage loan was involved? Were complete documents required from the borrower? Or was it a “no-doc” or “liar loan”?

The idea is to give investors more information in order to better judge the securities’ risk. That would reduce reliance on the Wall Street credit rating agencies who were widely criticized for failing to give investors adequate warning of the risks in subprime mortgage securities that triggered the financial crisis.

Investors also would get more time to study the offerings of asset-backed securities — a minimum of five days before the sale could begin. Currently there is no required minimum period.

“The proposed rules are intended to better protect investors in the securitization market by giving them more detailed information about pooled assets (and) more time to make their investment decisions,” SEC Chairman Mary Schapiro said before the vote.

By requiring securities issuers to retain some of the risk, the interests of the buyers and sellers would be put closer to an equal footing, she said.

Provisions in the House and Senate versions of financial overhaul legislation also would require the “securitizers” to keep some of the risk themselves.

The American Securitization Forum, representing the Wall Street firms that issue asset-backed securities, supports the SEC’s proposed disclosure requirements but is “deeply concerned” about the 5 percent risk-holding proposal, Tom Deutsch, the group’s executive director, said in a statement.

He said the SEC proposal could “severely limit” the volume of the securities issued without government support. That in turn “could significantly reduce the availability and affordability of private lending to consumers and small businesses over time,” Deutsch said.

As lawmakers and government agencies have been looking to lay down new rules for asset-backed securities, another idea is to set an industrywide lending standard that would govern minimum down payments, borrowers’ debt levels and other requirements. That too has drawn opposition from the financial industry.

The Federal Deposit Insurance Corp. has floated a proposal to require new lending standards. Asset-backed securities would have to meet the standards to maintain a guarantee that the government wouldn’t seize them if the bank failed.

FDIC Chairman Sheila Bair praised the SEC’s action in a statement issued Wednesday. “These proposals include essential elements of reform,” Bair said, and they “align with” the FDIC’s initiative.

But industry interests maintain that such rules would make banks skittish about investing in any mortgage-backed securities.

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