3. RESULTADOS Y DISCUSIÓN
3.1.1. RESULTADOS DEL LEVANTAMIENTO DE LA
3.1.1.2. Resultados de las encuestas y de los factores
The crisis in 2007-2008 was the result of many different dimensions of the American economy and its financial system. Cheap credit fueled an already-growing
134 The Enron case was also useful to stir discussions on corporate governance matters in Europe. See Paul
L. Davies, ‘Enron and Corporate Law Reform in the UK and the European Community’ in Klaus J. Hopt and others (eds), Corporate Governance in Context: Corporations, States and Markets in Europe, Japan, and the US (Oxford University Press 2005).
135 Sarbanes-Oxley Act of 2002, ss 101-109. 136 Sarbanes-Oxley Act of 2002, ss 201-209. 137 Sarbanes-Oxley Act of 2002, ss 301-305. 138 Sarbanes-Oxley Act of 2002, ss 401-409.
139See Roberta Romano, ‘The Sarbanes-Oxley Act and the Making of Quack Corporate Governance’ (2005)
housing bubble that had been developing since 1997,140 leading to a classic boom-and- bust scenario.
The increase in easy credit was a political response to the increasing income inequality that had been mounting in the United States. From 1975 to 2005, the income of those who earn more than the other 90% of the general population rose by around 65%, compared to those that are in the 10th percentile.141 Failing to deal with the situation through better education and unable to put forward income redistribution reforms, easier credit seemed the only politically feasible way to improve the livelihood of the general population.142 The policy was advanced through lower interest rates established by the Federal Reserve System143 and the use of government-sponsored entities promoting lending to low-income people, enabling them to afford housing.144
With the increasing availability of mortgages in the market, the private sector realized that they had a new business opportunity: they could buy mortgages, bundle them together and sell them to investors, creating profits in a relatively low-risk activity.145 The process was undertaken via special purpose vehicles, corporate entities which had, as their only raison d’être, the holding of mortgages and the issuing of securities to be sold on the market.146 In practice, this meant that these banks would not hold any risk on these mortgages; as long as they could be bundled and sold, banks would
140 From 1997 to 2006 house prices increased at an annual rate of 9.3% while building costs at a rate of
2.9%. See Marc Jarsulic, Anatomy of a Financial Crisis: a Real Estate Bubble, Runaway Credit Markets, and Regulatory Failure (Palgrave Macmillan 2010) 12.
141 Raghuram G. Rajan, Fault Lines; How Hidden Fractures Still Threaten the World Economy (Princeton
University Press 2010) 24.
142See ibid 24-31.
143 By November 2002 the Federal Reserve lowered the federal funds interest rate to 1.25%, set at 6.5% in
2000. John Cassidy, How Markets Fail: the Logic of Economic Calamities (Farrar, Straus and Giroux 2009) 222.
144 The two main government sponsored entities that had a role in the crisis were Fannie Mae and Freddie
Mac. See David Reiss, ‘Fannie Mae and Freddie Mac and the Future of Federal Housing Policy: a Study of Regulatory Privilege’ (2010) 61 Alabama Law Review 907.
145 This practice of financial institutions was begun in the 1990s. See The Financial Crisis Inquiry
Commission, The Financial Crisis Inquiry Report (2011) 68.
146 This process is known as securitization. Through securitization, the credit risk of the investment can be
isolated from the credit risk of the originator, not only facilitating the transaction that can be priced according just to its fundamentals, but also freeing originators from the credit risk of some of their assets. For more information about securitization, see Muñoz (n 21).
not have a strong incentive to carefully scrutinize them. This mortgage business model became known as the ‘originate-to-distribute’ model and was key in creating systemic risk in the market.
While mortgages were being securitized and distributed to the market, a demand from banks for this kind of asset was growing. Mortgage brokers were doing their job, but they also had an extra incentive to provide the mortgages that banks wanted: the higher the interest rate paid by the mortgagee, the higher the broker’s commission.147 The quality of the loan did not really matter, since in the end they would be pooled and sold to investors, what did matter was that there were loans to be used. The practice deteriorated to the point that loans were being made to persons with no income, no jobs and no assets – the infamous NINJA loans.148
While the quality of these loans was suffering considerably through the passage of time, investors were still happily buying mortgage-backed securities. Investors relied on Credit Rating Agencies to provide information about the risk of these products being sold instead of doing their own due diligence; at the same time, the Credit Rating Agencies were functioning as regulatory licensees, distributing licenses and being paid by the securitizers themselves to rate their products.149
The excess credit that was created through this practice led to a rise in United States’ housing prices. From 1997 to 2006, housing prices were increasing at a rate of 9.3%; meanwhile building costs were rising at a rate of only 2.9%.150 This was a growing bubble, becoming ripe to burst.
147 This kind of commission was known as the ‘yield-spread premium’. A higher interest rate, of course,
would increase the likelihood of default. The Financial Crisis Inquiry Commission, The Financial Crisis Inquiry Report (2011) 90.
148 NINJA loans were a consequence of the incentive system in the market at the time; for brokers, it was
important to create as many loans as possible, with the worst possible terms to the borrowers, while for the financial institutions securitizing these loans it was important just to have them and pass them along. The incentive system led to a lax screening of the mortgages being originated, and the market became populated with a high amount of low quality loans. See Benjamin J. Keys, Did Securitization Lead to Lax Screening?: Evidence from Subprime Loans in Robert Kolb (ed) Lessons from the Financial Crisis: Causes, Consequences, and our Economic Future (John Wiley & Sons 2010).
149 Brian J.M. Quinn, ‘The Failure of Private Ordering and the Financial Crisis of 2008’ (2009) 5 NYU Journal
of Law & Business 549, 567-82.
The stage was set for disaster. In 2006, the crisis started to unravel. Housing prices started to fall, homeowners were increasingly becoming unable to service their mortgages and by mid-2008, almost 4.5% of the subprime mortgages outstanding in the market were foreclosing.151 Even though there were a lot of investors buying these products, many of the financial intermediaries were also holding a substantial amount of them. Massive bank failures began to occur;152 a downward spiral was triggered, pushing markets into a nosedive. The Dow Jones Industrial Average reached its lowest point during the crisis on March 9, 2009, hitting 6.547 points.153
As the subprime crisis evolved in the U.S., international markets also started feeling its effects, while the real economy suffered the consequences.154 The expanding effects of the crisis prompted many policy responses and calls for reform all over the globe, leading to a restructuration of the global financial architecture.155
These reforms, contrary to what had happened after the accounting scandals in the United States, did not substantially alter the general liability framework of the players in securities issuance. In particular, cases reporting duties were modified,156 additional duties in specific financial transactions were required 157 and disclosure duties enhanced,158 mainly when related to Asset Backed Securities. The reform had an
151 Robert W. Kolb, The Financial Crisis of Our Time (Oxford University Press 2011) 61.
152 Bear Sterns, Lehman Brothers, Countrywide Financial, Washington Mutual and IndyMac were
extinguished, while Wachovia and Merryl Lynch were acquired by Wells Fargo and Bank of America. See ibid 74.
153 The Dow Jones was at 14,165 points on October 9, 2007. This was a fall of almost 54%.
154See Dirk G. Baur, Contagion and the Real Economy During the Global Financial Crisis in Robert W. Kolb
(ed) Financial Contagion: The Viral Threat to the Wealth of Nations (John Wiley & Sons 2011) Even though the U.S. subprime crisis might have been the fuse of the global crisis, many other countries also had been developing similar patterns of housing credit expansion. See FINANCIAL SERVICES AUTHORITY,THE TURNER REVIEW: A REGULATORY RESPONSE TO THE GLOBAL BANKING CRISIS (2009).
155 In the U.S., the reform of the system was done through the Dodd-Frank Wall Street Reform and Consumer
Protection Act in 2010, while in the EU the change came through the creation of the European System of Financial Supervision, a new framework for financial markets regulation at the European level. See Regulation (EU) 1092/2010, Regulation (EU) 1093/2010, Regulation (EU) No 1094/2010 and Regulation (EU) 1095/2010.
156See Suspension of the Duty to File Reports, SEC Release No. 34-65148 (August 17, 2011).
157 For example, the duty to perform a review regarding the assets used on an Asset-Backed Security. See
Issuer Review of Assets in Offerings of Asset-Backed Securities, Securities Act Release No. 33-9176 (January 20, 2011).
increased focus on avoiding systemic risk.159 On the other side of the Atlantic, in Europe, the reforms were mainly institutional, where the concern was focused more on facilitating a regulatory system where financial risks could be addressed at the European level.160
4.
Concluding Remarks
Financial crises have been one of the factors shaping the American system of securities regulation. Each of these crises discussed here had a different market failure that led to the crash of the financial system, resulting in long-lasting reforms to the regulatory landscape in the United States.
The importance of understanding the reasons that led to the creation and reform of the U.S. system of securities regulation is that it was the first well-known system of securities regulation and has served as a model to the creation of other systems. The market failures that the U.S. system addresses are the same as those that the other regulatory systems purport to address. This chapter thus provides a historical introduction to the theoretical discussion of securities regulation, which is undertaken in the next chapter.
159 For example, one of the provisions was studying a requirement to impose a minimum percentage of their
own products that securitizers had to hold, imposing a ‘skin in the game’ requirement. See Dodd-Frank Act;
see also Board of Governors of the Federal Reserve System, Report to the Congress on Risk Retention (2010).