Bear Stearns Pass Through Certificates -08-08093

National Debt

national debt


Mortgage Related

Government Sponsored

Announcement Date: October 6, 2016


On March 10, 2006, and March 31, 2006, SAMI Depositor and Bear Stearns Depositor, respectively, filed Registration Statements with the Securities and Exchange Commission (“SEC”) indicating their intention to sell $50 billion in MBS Certificates. (TAC ¶ 4.)2 The Registration Statements and the accompanying Prospectus and Prospectus Supplements (collectively referred to as “Offering Documents”) contained untrue statements and omissions of material fact regarding the underwriting and appraising standards, the value of the collateral, the amount of credit support for each offering, and the credit ratings of the Certificates. (Id. ¶ 9.) These omissions and misstatements are alleged to have caused the Offering Documents to be materially false and misleading. (Id.)

In brief, an MBS is created when a “depositor” buys an inventory of mortgages (or “loan pool”) from a primary lender (or “originator”).3 After the depositor obtains [851 F.Supp.2d 752] the loan pools, it places them in issuing trusts, securitizes them by organizing the loans into “tranches,” and issues securities backed by the loan pools. The depositor uses the borrowers’ monthly payments as the revenue stream to pay investors who have bought the securities. Each tranche has a different risk profile and is assigned a credit rating — here, by the rating agencies S & P and Moody’s (“Rating Agencies”).4 All of the tranches from which named Plaintiffs purchased Certificates were initially rated AAA, which ostensibly indicated the lowest likelihood of default.5(TAC ¶¶ 40-41.)

Because the value of an MBS depends on the ability of the borrowers to repay the principal and interest on the underlying loans as well as the adequacy of the collateral in the event of default, thorough assessments of the borrowers’ creditworthiness and the homes’ values are paramount. (Id. ¶ 3.) To this end, the MBS packaging process has three principal levels of quality control. First, underwriting and appraisal standards are crafted to assist the originator in weeding out excessively risky loan applications; second, the depositor reviews the loan pools to ensure that they meet the originator’s stated underwriting standards (id. ¶¶ 55-58); and third, the Rating Agencies review the securities’ risk profiles and assign ratings. (Id. ¶¶ 6, 184-85.)

The TAC details a systemic breakdown at each level, one that resulted largely from the misalignment of incentives in the MBS industry. Under the traditional mortgage investment model, the loan originator held the mortgage to maturity and made its profits from the borrower’s payment of interest and repayment of principal-an arrangement that gave the originator an economic interest in ensuring that (1) the borrower had the financial wherewithal to repay the promissory note, and (2) the underlying property had sufficient value to cover the lender’s losses in the event of default. (Id. ¶¶ 44-47, 168.) With the advent of securitization, originators quickly parted with the mortgages — and the attendant risk of default — by selling them to investors. (Id. ¶ 169). The primary source of profit shifted from borrowers’ interest payments to loan fees and sales revenue. Largely free from the risk of defaults, originators began pushing high-risk loan products and deviating from underwriting and appraisal standards in an attempt to maximize loan volume. (Id. ¶¶ 169-70). Wall Street banks like Bear Stearns, which profited enormously from the packaging and sale of MBS, were content to overlook the widespread degradation of underwriting and appraisal practices. (Id. ¶¶ 56-67, 171.) The final guarantors of the securities’ quality, the Rating Agencies, were equally compromised. The Rating Agencies’ models were outdated and failed to properly account for the increased riskiness of new loan products. (Id. ¶ 196.) Compounding the problem, banks such as Bear Stearns shopped for Rating Agencies willing to assign their securities top credit ratings, pitting the Agencies against each other [851 F.Supp.2d 753] and provoking a race to the bottom in rating quality. (Id. ¶¶ 195.)