Subprime Mortgages and Theories of Liability-Deja Vu (Part Four)

Part One of this series covered some features of the subprime mortgages now defaulting in huge numbers and how these features had been seen in many improper transactions that led to the Savings and Loan Crisis of the early 1990s, and in the more recent corporate governance scandals associated with enormous investor losses typified by Enron and WorldCom.

Part Two examined some statistics and problems with liability theories plaintiffs are asserting to establish the liability of defendants in various securities class actions seeking damages claimed to have been caused by the implosion of the subprime mortgage market.

Part Three addressed the heightened pleading requirements for falsity and scienter imposed by the Private Securities Litigation Reform Act of 1995 (PLSRA) and how the caselaw interpreting these provisions makes it very hard for class action plaintiffs to successfully establish secondary liability of defendants.

This part (Part Four) of the series provides links to and summarizes some of the more interesting observations made by made by leading commenators about various aspects of the subprime market collapse and related issues.

Although a considerable amount of scholarly work is being conducted about various aspects leading to the collapse of the subprime mortgage markets, a lot of it seems to be educated guesswork—and should be critically analyzed. In addition to some of the suggested readings that I previously noted in Part One, readers may find the following articles and reports particularly interesting:

• Donald Nordberg, Waste makes Haste: Sarbanes-Oxley, Competitiveness and the Subprime Crisis, Working Paper (May 10, 2008), available at http://ssrn.com/abstract=1131674 (commenting, in part, on some similarities between the subprime lending markets and the problems underlying Enron and similar companies: "Despite the differences, there are some eerie similarities. Both involved hyperactive financial intermediaries. Both involved use of new instruments of finance to offload risk, and in particular the use of off-balance sheet entities to disguise (in the case of Enron) or just 'distribute' (in the case of subprime CDOs) the risk."). ©Donald Nordberg,Waste makes haste, at 21;

• Christopher L. Foote, et al., Fed. Reserve Bank-Boston, Public Policy Discussion Papers No. 08-2, Subprime Facts: What (We Think) We Know about the Subprime Crisis, and What We Don't (May 30, 2008), available at http://papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID1153411_code349801.pdf?abstractid=1153411&mirid=2 (Rejecting the popular argument that subprime mortgage "resets" were a major problem: "Proponents of the centrality of resets in the current crisis based their view on the following logic. Subprime hybrid ARMs offer borrowers extremely low 'teaser' rates for some initial period . . . but then these mortgages 'explode' to high rates thereafter. Lenders find such loans attractive because of the high post-reset interest rates. Borrowers find them attractive because of the teaser, but then regret their decisions when they find themselves paying high interest rates. Is this an accurate description of the subprime lending model? No.");

• Adam B. Ashcraft and Til Schuermann, Federal Reserve Bank of New York, Understanding the Securitization of Subprime Mortgage Credit,Staff Report No. 318 (March 2008), available at http://papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID1071189_code599.pdf?abstractid=1071189&mirid=2 (describing the key players involved in the securitization process and noting there are seven key frictions among them based on the asymmetry of information available—i.e., that some players lacked sufficient information to properly evaluate the degree of risk involved);

• John Kiff and Paul Mills, Money for Nothing and Checks for Free, Working Paper WP/07/188, International Monetary Fund (July 2007), available at http://www.imf.org/external/pubs/ft/wp/2007/wp07188.pdf (noting that the impact of the market's implosion has been limited to certain sectors as a result of securitization: "[W]hile some structured credit hedge funds have suffered large losses, mortgage securitization appears to have helped disperse the impact throughout the financial system, in contrast to the Savings & Loan crisis of the early 1990s. The credit cycle is thus largely playing out in the securities and derivatives markets, rather than on bank balance sheets.");

• Roberto G. Quercia, et al., The Impact of Predatory Loan Terms on Subprime Foreclosures: The Special Case of Prepayment Penalties and Balloon Payments, Housing Policy Debate, Vol. 18, Issue 2 (2007), available at http://www.ccc.unc.edu/documents/foreclosurepaper.pdf (examining the impact of two predatory loan terms—prepayment penalties and balloon-payment requirements—on foreclosure and prepayment propensities within the subprime first-lien refinance market and and concluding that "extended prepayment penalties and balloon payments signifcantly increase the odds of foreclosure");

• Robert E. Lang, Katrin B. Anacker, and Steven Hornburg, The New Politics of Affordable Housing, Housing Policy Debate, Vol. 19, Issue 2 (2008), available at http://www.mi.vt.edu/data/files/hpd%2019.2/1._hpd_forum_web.pdf (tracing the history of the federal initiatives for affordable housing, such as mortgage insurance by the Federal Housing Administration (FHA) and mortgage guarantees by the Veterans Administration (VA) and questioning about whether the current subprime mortgage crisis will once again place affordable housing high on the national agenda);

• Ronald D. Utt, Comment on Robert E. Lang, Katrin B. Anacker, and Steven Hornburg’s “The New Politics of Affordable Housing,” Housing Policy Debate, Vol. 19, Issue 2 (2008), available at http://www.mi.vt.edu/data/files/hpd%2019.2/3._hpd_utt_web.pdf (the author, from the Heritage Foundation, believes that the regulatory costs from federal housing programs may have some connection to the subprime mortgage problems: "There is also reason to believe that some portion of what is now seen as the subprime crisis will be found to be the market’s response to the growing mismatch between incomes and home prices that land regulations have caused."); and

• Steven L. Schwarcz, Protecting Financial Markets: Lessons from the Subprime Mortgage Meltdown, Duke Research Paper No. 175 (Nov. 2007), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1056241 (exploring why the subprime financial crisis occurred despite the number of different protections to regulate the financial markets, along with the "the market-discipline approach undertaken by the second Bush administration, and what this crisis can teach us about protecting financial markets").

More to Come

©Michael E. Clark, Hamel Bowers & Clark LLP. Information provided in this blog does not, nor is it intended to, create an attorney-client relationship. Rather, it is offered solely for informational purposes and is not intended to constitute advertising. More information about me, my practice, background, and interests, is available from the firm website, www.lawyers.com/hamelbowers&clark, and the following sites (including links to some of my published papers and articles: www.avvo.com/attorneys/77007-tx-michael-clark-121553.html and www.superlawyers.com/texas/lawyer/Michael-E-Clark/a051f497-181f-4399-862b-cd4a7ad5c1cf.html

The pharmaceutical law treatise for which I am Editor-in-Chief was published in December 2007 by the ABA Section of Health Law/BNA and is now in supplementation for 2008. See http://storefront.bnabooks.com/epages/bnastore.sf/en_US/?ObjectPath=/Shops/bnastore/Products/9765.

I will be moderating a panel for the Third National Securities Fraud Institute to be held in Arlington, VA on October 2-3, 2008 at the Hyatt Regency-Crystal City. This panel will focus on the continuing importance placed by federal regulators on revenue recognition issues, and examine SABs 99, 101, and 104. Details about the upcoming event are available at http://www.abanet.org/cle/programs/n08sfr1.html