The Roberta Mitchell Lecture: Structuring Responsibility in Securitization Transactions

• Author: Steven L. Schwarcz
• Pages: 803-819

THE ROBERTA MITCHELL LECTURE:∗ STRUCTURING

RESPONSIBILITY IN SECURITIZATION TRANSACTIONS

STEVEN L. SCHWARCZ∗∗

I. INTRODUCTION

It has been my pleasure and honor to present the first Roberta Mitchell

Lecture, and to have done so in connection with this symposium on the

mortgage-foreclosure crisis. Although this article (based on that lecture)

does not address mortgage foreclosure per se, it provides a context in

which the crisis can be better understood.

Any discussion of the mortgage-foreclosure crisis must begin with

securitization. Securitization facilitates mortgage lending by enabling

lenders to easily monetize existing mortgage loans, thereby generating cash

to make new loans.1 Many believe, however, that the originate-to-

distribute model of securitization—enabling lenders to sell off their loans

as they are made—caused mortgage lenders to relax their lending

standards, leading to the multitude of risky subprime loans that now

constitute a huge portion of the foreclosures.2

In other contexts, I have argued that the originate-to-distribute model

of securitization was not the primary culprit. There was significant

government pres sure on mortgage le nders to make and se curitize subprime

Copyright © 2012, Steven L. Schwarcz.

∗ Symposium, The Foreclosure Crisis: New Strategies for Addressing the National and

Local Calamity, 40 CAP. U. L. REV. 803 (2012).

∗∗ Stanley A. Star Professor of Law & Business, Duke University School of Law, and

Founding Director, Duke Global Capital Markets Center; schwarcz@law.duke.edu. I thank

Sergio Nasarre Aznar for valuable comments on drafts of this lecture and article, and Arie

Eernisse and Gregory McKay for invaluable research assistance. Although I am serving as

a consultant and potential expert witness in a case that raises some of the issues discussed in

this lecture and article, the views expressed here are en tirely my own.

1 See, e.g., Stephen M. Juris, Scandal: Subprime Meltdown, Securitization Accounting,

237 N.Y. L.J. 4 (2007); FRANK J. FABOZZI & VINOD KOTHARI, INTRODUCTION TO

SECURITIZATION 3–11 (2008) (explaining that securitization is a vehicle for capital

formation).

2 See, e.g., Kurt Eggert, The Great Collapse: How Securitization Caused the Subprime

Meltdown, 41 CONN. L. REV.1257, 1257–1311 (2009).

804 CAPITAL UNIVERSITY LAW REVIEW [40:803

mortgage loans to expand homeownership.3 The fall in lending standards

may also reflect distortions caused by the liquidity glut of that time, in

which lenders competed aggressively for business.4 Or, it may reflect

conflicts of interest between lending firms and their employees in charge

of setting lending standards, such as paying employees for booking loans

regardless of the loans’ long-term performance.5

Blaming the originate-to-distribute model also does not explain why

lending standards were not similarly lowered for non-mortgage securitized

loans. Nor does it explain why institutional investors—those who took the

bottom-line risk on the value of the mortgage loans—did not govern their

investments by the same strict lending standards they would observe but

for the separation of origination and ownership.

Regardless of what caused mortgage lending standards to fall, there is

no question that securitization increased the number of mortgage loans—

and thus the number of subprime mortgage loans—that could be (and in

fact were) made. This article begins by explaining securitization as well as

the parties in securitization transactions. In that context, it explores a

conundrum that I call the “protection gap.”

II. THE PROTECTION GAP

A. Positing the Protection Gap

In complex securitization transactions, there is the following

significant protection gap: When entering into a transaction, parties may be

unable or unwilling to pay the price for full protection.6 As a result,

transaction parties may choose or are forced to assume the good faith of

the other parties to the transaction and the consistency and completeness of

protections provided in the transaction documents. When things go wrong,

fingers are pointed at alleged wrongdoers, especially those with deep

pockets.

3 See, e.g., Peter J. Wallison, The Lost Cause: The Failure of the Financial Crisis, FIN.

SERVS. OUTLOOK Jan.–Feb. 2011, available at http://www.aei.org/files/2011/02/10/FSO-

2011-02-g.pdf.

4 Id. at 3–4 (noting the deterioration of mortgage underwriting standards in the years

prior to the bubble’s collapse).

5 Carlos Garriga, Lending Standards in Mortgage Market, ECON. SYNOPSES, May 6,

2009, at 1, available at http://research.stlouisfed.org/publications/es/09/ES0923.pdf

(describing the loose lending standards through statistics).

6 See generally FABOZZI & KOTHARI, supra note 1, at 306–10 (explaining the concept of

protection buying and selling).