Complexity, Complicity, and Liability Up the Securitization Food Chain : Investor and Arranger Exposure to Consumer Claims

Old laws and complex, innovative finance do not make good partners, particularly in the area of consumer law. Today, tremendous uncertainty exists about the extent to which consumers might have claims against arrangers and investment trusts based on misdeeds at the origination of their loans. For financial services firms, the uncertainty impedes their ability to calculate potential legal liabilities, which in turn makes it difficult to accurately price credit and securities backed by loans. Regulators, who are charged with assuring the safety and soundness of banks and thrifts, likewise, cannot readily determine the dent consumer claims might make in banks' balance sheets. To add to these difficulties, the laws governing consumer lending were a challenge to parse even before home loan financing moved from Main Street to Wall Street. Credit raters, lawyers and others issued countless reports and white papers during the subprime boom speculating about consumer claims and who might be liable for what types of wrongdoing. Those questions were never resolved and there was little incentive to resolve them. Originators, servicers, arrangers, and investors were all making substantial short-term profits. Borrowers in default rarely brought claims against anyone in the securitization chain because it was easier and far less expensive to refinance than find and engage an attorney to determine the existence of claims and pursue them against defendants with much deeper pockets. But this situation has changed: the availability of mortgage credit has fallen sharply, borrowers are challenging foreclosures in court, and borrowers and states are bringing actions against parties in the securitization chain based on alleged unlawful origination practices. This Article is the first to assess consumer claims against arrangers and investment trusts in light of the evolution of financial institutions as securitization of home loans took off. Our analysis is critical because the government is embarking on plans for a new system for housing financing, which we contend must clarify the liability of participants in the securitization food chain so that the market can accurately price securities and loans up-front. This system must also create better incentives to encourage the creation of effective compliance programs to stop problem loans from entering the pipeline