Litigation Issues Arising from the Credit Crisis

This post is by Allen Ferrell of Harvard Law School.

My co-authors (Jennifer Bethel and Gang Hu) and I have updated our paper, including the inclusion of current data, entitled “Legal and Economic Issues in Litigation Arising from the 2007-2008 Credit Crisis” which can be downloaded here. The paper is forthcoming in a Brookings volume on the credit market crisis.

The paper surveys the current securities class action litigation arising out the credit crisis (10b-5, section 11, section 12(a)(2)) and some of the important securities law principles that will be at play in the resolution of this litigation. In particular, we focus on the following three securities law principles in our discussion: (1) no fraud by hindsight; (2) truth on the market defenses; and (3) loss causation issues. We also provide data on various aspects of the securitization process that intersect with the application of these principles. For instance, with respect to the “truth on the market” defense (i.e., that the purported disclosure deficiencies were not material given the information the market already had) we discuss the fact that the quality of disclosures in the mortgage backed securities registration statements (and virtually all mortgage backed securities were registered) actually improved between 2001 to 2006 (in part due to the promulgation of Regulation AB in 2004) and that it was quite clear from these registration statements that the quality of the underwriting in a number of instances had declined. Moreover, the scope of commercial banks’ asset backed commercial paper conduit liquidity exposures were explicitly disclosed in their public Form Y-9C filings with the Federal Reserve. Moreover, asset backed commercial paper conduit disclosures provided to the commercial paper investors, such as hedge funds, included information concerning the liquidity guarantees provided by the banks.

We also discuss the source of many of the losses and writedowns suffered by the banks, particularly in 2007 and the first half of 2008, which is important in assessing the securities class action litigation. Many banks suffered substantial losses due to their “super senior” positions in CDOs and various liquidity guarantees to asset backed commercial paper conduits, rather than directly on their mortgage-backed security holdings.

We also provide in the paper data on, among other things, the tranche structure of mortgage-backed securities, securitization deal sizes, reported value at risk estimates by banks, CDO liquidations and CDO trustee information.

The paper is available here.

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