WASHINGTON -- Financial firms that sell securities backed by loans, such as the kind that fueled the 2008 financial crisis, will have to give investors details on borrowers' credit record and income under action taken Wednesday by federal regulators.
The Securities and Exchange Commission adopted the rules for securities linked to mortgages and auto loans on a 5-0 vote.
The commissioners also imposed new conflict-of-interest rules on the agencies that rate the debt of companies, governments and issues of securities. That vote split 3-2 along party lines, with the two Republican commissioners opposing adoption of the rules.
Home mortgages bundled into securities and sold on Wall Street soured after the housing bubble burst in 2007, losing billions in value. The vast sales of risky securities ignited the crisis that plunged the economy into the deepest recession since the Great Depression and brought a taxpayer bailout of banks.
In requiring sellers of the securities to provide information on borrowers' credit and income, the aim is to enable investors to better assess the risks of the loans underlying the securities.
“These reforms will make a real difference to investors and to our financial markets,” SEC Chairwoman Mary Jo White said before the vote.
A recent report by the Federal Reserve Bank of New York showed that U.S. auto loans jumped to the highest level in eight years this spring, fueled by a big increase in lending to risky borrowers.
The Fed also said that loans to borrowers with weak credit, known as subprime loans, continue to make up a smaller proportion of total auto loans than before the recession.
Still, the rapid increase in subprime auto lending has raised concerns among federal regulators in recent months that it could set off a wave of defaults such as those that occurred in the mortgage market collapse.
Because auto loans are packaged into securities, an increase in auto loan defaults could be amplified.
The new rules on so-called asset-backed securities and credit rating agencies were called for under the sweeping financial overhaul law enacted in 2010 in response to the financial meltdown. The rules take effect in 60 days.
A number of big banks, including JPMorgan Chase (NYSE: JPM), Bank of America (NYSE: BAC), Citigroup (NYSE: C) and Goldman Sachs (NYSE: GS), have been accused by the government of abuses in sales of mortgage securities in the years leading up to the crisis.
Together, they have paid hundreds of millions in penalties to settle civil charges brought by the SEC, which accused them of deceiving investors about the quality of the securities they sold.
In recent months, the Justice Department and state regulators have reached multibillion-dollar civil settlements over mortgage securities with JPMorgan, Bank of America and Citigroup.
The new rules require credit rating agencies to report to the SEC on their financial safeguards to ensure that their ratings are determined through a fair process. The agencies' salespeople will be barred from participating in the ratings process. And agencies will have to review and potentially revise their ratings in cases where an employee was later hired by a company he or she rated.
The rating agencies are key financial gatekeepers. Their ratings can affect a company's ability to raise or borrow money and also can influence how much investors pay for securities. Critics say the agencies have a built-in conflict of interest because they are paid by the same companies they rate. The three big agencies -- Moody's, Standard & Poor's and Fitch -- were widely criticized for giving low-risk ratings to the risky mortgage securities being sold ahead of the crisis, as they reaped lucrative fees.
Investigations by a Senate panel and a congressionally appointed independent commission found that the three agencies contributed to the crisis by awarding high ratings to securities based on subprime mortgages.
The three big agencies together account for nearly 95 percent of the ratings market. Several other smaller rating agencies are officially recognized by the SEC.
A big problem is that companies choose which firms rate them and then pay for those ratings, critics say. It's like having a pitcher choose the umpire for a baseball game, they contend, and it puts pressure on the agencies to award better ratings in order to secure repeat business.
Critics say a better solution would be to create a government board that randomly assigns agencies to rate companies.
Congress debated that idea, but ultimately decided not to direct regulators to adopt such rules. Instead, lawmakers asked the SEC to study the idea.