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 FINANCIAL CRISIS INQUIRY COMMISSION REPORT

misrepresentations” in the registration statements and prospectuses provided to in-
vestors who purchased securities. They generally allege violations of the Securities
Exchange Act of  and the Securities Act of .
Both private and government entities have gone to court. For example, the invest-
ment brokerage Charles Schwab has sued units of Bank of America, Wells Fargo, and

UBS Securities. The Massachusetts attorney general’s office settled charges against
Morgan Stanley and Goldman Sachs, after accusing the firms of inadequate disclo-
sure relating to their sales of mortgage-backed securities. Morgan Stanley agreed to
pay  million and Goldman Sachs agreed to pay  million. 
To take another example, the Federal Home Loan Bank of Chicago has sued sev-
eral defendants, including Bank of America, Credit Suisse Securities, Citigroup, and
Goldman Sachs, over its . billion investment in private mortgage-backed securi-
ties, claiming they failed to provide accurate information about the securities. Simi-
larly, Cambridge Place Investment Management has sued units of Morgan Stanley,
Citigroup, HSBC, Goldman Sachs, Barclays, and Bank of America, among others, “on
the basis of the information contained in the applicable registration statement,
prospectus, and prospective supplements.” 

LOSSES: “WHO OWNS RESIDENTIAL CREDIT RISK?”
Through  and into , as the rating agencies downgraded mortgage-backed
securities and CDOs, and investors began to panic, market prices for these securities
plunged. Both the direct losses as well as the marketwide contagion and panic that
ensued would lead to the failure or near failure of many large financial firms across
the system. The drop in market prices for mortgage-related securities reflected the
higher probability that the underlying mortgages would actually default (meaning
that less cash would flow to the investors) as well as the more generalized fear among
investors that this market had become illiquid. Investors valued liquidity because
they wanted the assurance that they could sell securities quickly to raise cash if neces-
sary. Potential investors worried they might get stuck holding these securities as mar-
ket participants looked to limit their exposure to the collapsing mortgage market.
As market prices dropped, “mark-to-market” accounting rules required firms to
write down their holdings to reflect the lower market prices. In the first quarter of
, the largest banks and investment banks began complying with a new account-
ing rule and for the first time reported their assets in one of three valuation cate-
gories: “Level  assets,” which had observable market prices, like stocks on the stock
exchange; “Level  assets,” which were not as easily priced because they were not ac-
tively traded; and “Level  assets,” which were illiquid and had no discernible market
prices or other inputs. To determine the value of Level  and in some cases Level  as-
sets where market prices were unavailable, firms used models that relied on assump-
tions. Many financial institutions reported Level  assets that substantially exceeded
their capital. For example, for the first quarter of , Bear Stearns reported about
 billion in Level  assets, compared to  billion in capital; Morgan Stanley re-