Securities Law Prof Blog

Editor: Eric C. Chaffee
Univ. of Toledo College of Law

Monday, August 4, 2014

Horton on Mortgage-Backed Securities

Brent J. Horton has posted For the Protection of Investors and the Public: Why Fannie Mae’s Mortgage-Backed Securities Should Be Subject to the Disclosure Requirements of the Securities Act of 1933 on SSRN with the following abstract:

Despite the fact that Fannie Mae’s creation of mortgage-backed securities (MBS) played a major role in causing the 2008 financial crisis, the issue of reforming Fannie Mae’s securitization activities was ignored by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, Congress’ legislative response to the crisis. Former Secretary of the Treasury Henry Paulson said in a February 5, 2014 interview with the Washington Times, “[i]t perplexes me that nothing has been done." Paulson worries that if nothing is done, any future failure of Fannie Mae — a very real possibility absent reform — will lead to what he calls a financial “horror show,” and that the “ensuing crisis [will be] much bigger than the financial collapse in the wake of the Lehman bankruptcy.”

Given the urgency of the matter, it is surprising that post-2008 financial crisis scholarship — much like Congress — has largely ignored the need to reform Fannie Mae. The scholarship that does exist on the topic tends to recommend abolishing Fannie Mae (allowing the private sector to fill the hole). This Article fills a major gap in the scholarly debate. This Article recognizes that Fannie Mae plays an important role in financing home ownership, and accordingly, proposes a solution that will maintain Fannie Mae, but constrain its risk taking in the future. Because as Louis Brandeis famously stated, “sunlight is said to be the best of disinfectants; electric light the most efficient policeman,” this Article proposes that the best way to reduce risk taking at Fannie Mae is to subject its MBS offerings to the disclosure requirements of the Securities Act of 1933. As this Article explains, right now — as was the case in 2008 — Fannie Mae only engages in ad-hoc voluntary disclosure, which is void of substance, and entirely inadequate given the number of investors that purchase its MBS daily.

In arguing that Fannie Mae’s MBS should be subject to the disclosure requirements of the Securities Act of 1933, this Article moves beyond the traditional justification — investor protection — and argues that disclosure can protect the taxpaying public. After all, in 2008, it was the taxpaying public that was called upon to bailout investors in Fannie Mae’s MBS. The bill was $116 billion. While subjecting Fannie Mae to the disclosure requirements of the Securities Act of 1933 to protect the taxpaying public is a novel application of the law, it is not without support. It is supported by the language of the Securities Act itself, which calls in several places for the “protection of the public.”

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