The SEC and California and Solving the Mortgage Crisis

One issue that remains yet to be addressed is how to prevent the mortgage crisis from happening again.  One of the many problems was the origination of loans by putting homeowners into mortgages that they couldn't afford. 

Well, it seems that two organizations taking lumps these days may have developed a solution.  Anyone following the ups and downs of the State of California knows that the government has run out of money and had to issue script (otherwise known as "registered warrants").  The effort has largely engendered derision and been bantered around as a sign of financial profligacy. 

The SEC, however, put things on a higher plane with a press release indicating that the script had obtained the lofty status as securities.  According to the SEC:

• The staff of the Securities and Exchange Commission has expressed its belief that California’s recently-issued IOUs are “securities” under federal securities law. As such, holders of these IOUs and those who may purchase them are protected by the provisions of the federal securities laws that prohibit fraud in the purchase or sale of securities.

In other words, the script is subject to the antifraud provisions.   The antifraud rules prohibit fraud in connection with the purchase or sale of securities.  That means if anyone lies in exchange for the script, they can be sued under the ominous Rule 10b-5.  Dishonest vendors causing holders to part with their script, ne'er-do-well children who fraudulently induce their parents to accept the IOUs, and taxi cab drivers who receive script after fraudulently misrepresenting that they took the shortest route, will all be subject to suit under Rule 10b-5.

But back to the mortgage crisis.  Anyone taking out a mortgage in California should try to pay the assorted fees owed the originator in script.  Then if the mortgage broker misrepresents that the borrower can afford the product or that it is safe, Rule 10b-5 will provide the necessary relief.  Class actions will proliferate.  As with disclosure by companies, the threat of an action under 10b-5 will likely induce a more accurate and transparent mortgage process.

Perhaps other states should consider the California approach and issue script.  Moreover, the script could eventually be used only in connection with mortgages.  That would mean all future mortgages were subject to restraints on false disclosure imposed under Rule 10b-5.  It is a solution of sorts and one that could only arise from the interaction of California and the SEC.