Subprime Mortgage Markets’ Collapse to the Credit Markets'Michael E. Clark
February 10, 2009 — 1,692 views
The Subprime Mortgage Market Collapse
Part One of the blog series about the Subprime Mortgage Market Collapse addressed some key features of the subprime mortgages now defaulting in huge numbers and it noted how these features were similar to those seen in many improper transactions that preceded the Savings and Loan Crisis of the early 1990s, as well as in more recent corporate governance scandals.
Part Two of that series 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 cases interpreting these provisions have made it very hard for class action plaintiffs to successfully establish secondary liability of defendants.
Part Four provided links to and summarized some of the more interesting observations made by leading commentators about various aspects of the subprime market collapse and related issues.
The Spreading Damage to Other Sectors of the Economy in the United States and Beyond
The United States and other nations now are mired in a far broader financial downturn than the one following the collapse of the subprime mortgage markets. The broader lending market for all types of mortgages has been seriously affected, as have commercial lending activities, and businesses throughout various segments of the economy are reporting serious difficulties due to the sagging consumer confidence. Recently, most retailers have reported that they experienced one of their worst holiday seasons in years.
Against fears of these problems further deepening and broadening, Congress and the Executive Branch have been pressured to save the nation's large automakers from bankruptcy. The best argument for such an intervention appears to be that unless the government props up this major domestic industry, shockwaves will not only affect the supply chain that supports the manufacture and sale of domestic automobiles, but could cascade into other industries (i.e., a systemic risk of a broader collapse).
The Revenge of the Regulators is Near
Unfortunately, the incoming Obama Administration must make difficult and quick policy decisions about measures that will restore the confidence of consumers and foreign investors in our markets. Calls are being made for Congress and the Executive Branch to more tightly regulate the financial markets; but such efforts may be counterproductive in the long run since regulatory actions are often too blunt an instrument to use when attempting to fix complex problems. On the other hand, Congress undoubtedly will enact some reform measures (and various agencies will implement new or amended regulations) intended to fix the marketplace failures. A recent, classic example of this phenomenon is revealed by the hodgepodge of features contained in the SarbanesOxley legislation which was enacted without sufficient, critical review. As I noted about that major reform legislation, Congress then felt that swift action was needed to restore consumer confidence:
Worried that this loss of confidence could lead to another great stock market crash, Congress felt compelled to quickly act before learning why various corporate governance controls that were designed to stop such conduct had failed. Yet, before this crisis of confidence about the financial markets developed, leading figures had been trying to convince businesses, their leaders, and the investing public to change their ways and lower their expectations about getting huge returns each year on investments. For example, in a famous speech, Arthur Levitt, then Chairman of the Securities Exchange Commission, discussed the evils of business accountants engaging in "earnings management," a common business practice that he disparagingly called the "numbers
game[.]" See Michael E. Clark, Hamstrung or Properly Calibrated: Federalism and the Appropriate Role of Government in the PostSarbanesOxley World, 4 Internat'l J. Disclos. and Governance No.1 (2004) pp. 385412(28) (internal citations omitted).
While it is debatable whether SarbanesOxley's reform measures helped to restoring consumer confidence at that time, the legislation's longterm goal of limiting and preventing future widespread corporate scandals hasn't been realized. Even if additional statutory and regulatory measures are enacted and implemented that criminalize violations of such new rules, it probably won't take too long for incentivized individuals to find ways to circumvent these prohibitions.
Rulesbased regimes aren't nearly as effective as those based on core principles and criminal statutes should be limited to addressing the most egregious conduct. In fact, so many federal laws and regulations now carry potential criminal sanctions that it is nearly impossible to identify how many of them actually exist. As I have noted elsewhere, "[t]he problems caused by this legislative trend involve more than simply accounting for the sheer number of federal criminal offenses that now are "[s]o large ... that there is no conveniently accessible, complete list of federal crimes." Michael E. Clark, The Revenge of the Regulators, paper presented for the Section of Business Law at the ABA Annual Meeting 2004 (paper on file with author citing to the "Federalization of Criminal Law," ABA Task Force on the Federalization of Criminal Law (1998) at 9. More importantly, as the ranks of federal law enforcement agencies become inflated, bureaucrats try to find new areas where they can deploy resources to combat crime, and this may result in a cycle of broadening federal investigations and prosecutions into areas traditionally handled by state and local officials (and that lack any real federal nexus). According to the ABA's Task Force on the Federalization of Criminal Law, over 40% of all federal criminal laws on the books have been enacted during recent decades. See ABA Task Force on the Federalization of Criminal Law, The Federalization of Criminal Law (1998), at 7.
©Michael E. Clark
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