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Regulatory revamp for lending industry

Next up for new regulation: The Obama administration plans to reform securities at heart of the economic crisis.

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The result? “A serious market failure that fed the housing boom and deepened the housing bust,” according to Treasury Department spokesman Andrew Williams.

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The administration’s proposal is not just an attempt to clean up the securitization market. The goal is also to help revive that market, which has seen almost no activity in the last year.

That goal was welcomed by industry groups, even as they cautioned that some details needed further examination.

“There may be parts of this proposal where the industry disagrees, but we pledge to work closely with the administration and global policymakers on this vital topic,” said George Miller, executive director of the American Securitization Forum.

The proposal assigns a key role to the Securities and Exchange Commission, which regulates the sale of securities. In addition to requiring increased disclosures about the contents of each security, the agency also would expand its database of corporate bond issues to include asset-backed securities. And the SEC would encourage the adoption of standardized contract language to reduce confusion and allow investors to compare securities more easily.

A second component focuses on the credit rating agencies, which have faced criticism for assigning their safest grades to hundreds of securities that ended up losing large portions of their value because they contained mortgage loans that borrowers could not afford. The proposal would require a clear distinction between the ratings assigned to asset-backed securities and other forms of debt such as corporate bonds. The agencies also would be required to disclose more information about their methodology, and about conflicts of interest. Generally, the agencies are paid by the company that issues the security.

The final component addresses financial incentives, for instance requiring firms to retain a stake in each security. The plan also would prohibit firms from hedging that risk, meaning that they could not make an offsetting investment. The European Union plans to adopt a similar requirement, an important consideration because firms could easily shift the sale of asset-backed securities to a less restrictive marketplace.

But some officials and financial experts still are skeptical about the requirement. They note that lenders often kept a piece of their securitizations during the housing boom, either as a desirable investment or because it could not be sold. This retained risk was a key source of the losses that crippled Citigroup and other banks.