The Mortgage Meltdown and the Failure of Investor Protection

Abstract

The aftermath of the US mortgage meltdown of the late 2000s revealed the biggest failure of investor protection since the Great Depression: the securities laws did not allow investors in non-agency mortgage-backed securities (MBS) to recover losses on the securities even though there had been material misstatements and omissions when the securities were sold. The key issue was the short time limit for starting a lawsuit under those laws. Many investors did not become aware of the nature of their claims until after the time limit had expired. A lot of investors pursued alternative legal theories, such as contract claims, but short time limits were also an issue there. The mortgage meltdown produced losses on the order of $1 trillion (±20%), most of which were borne by non-agency MBS investors. The underlying cause of those losses was an industry-wide breakdown of mortgage lending and securitization practices from around 2005 through 2007. The nature of that breakdown was not fully revealed until many years later through investigations by the US Department of Justice, which revealed the nature and extent of the problems in a series of major settlements starting in 2013.

TOPICS: MBS and residential mortgage loans, financial crises and financial market history, CMBS and commercial mortgage loans

Key Findings

• • The mortgage meltdown produced $1 trillion (±20%) of losses from 2007 through 2016. The losses were borne primarily by investors in non-agency mortgage-backed securities (MBS).

• • The cause of the mortgage melt-down was an industry-wide breakdown of loan origination and securitization practices. The breakdown of practices was not disclosed to non-agency MBS investors when they made their investments.

• • Laws intended to protect investors from misstatements or omissions in the sale of securities did not work effectively. The maximum time limit for starting lawsuits to recover losses was very short. In most cases, the time limit expired before investors even learned the relevant facts about how they had been misled.