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Case 1:11-cv-00779-TCW Document 428 Filed 02/19/15 Page 1 of 573 IN THE UNITED STATES COURT OF FEDERAL CLAIMS STARR INTERNATIONAL COMPANY, INC., on its behalf and on behalf of a class of others similarly situated, Plaintiff, No. 11-00779C (TCW) v. THE UNITED STATES, Defendant. PLAINTIFFS’ PROPOSED FINDINGS OF FACT BOIES, SCHILLER & FLEXNER LLP BOIES, SCHILLER & FLEXNER LLP Robert B. Silver David Boies Robert J. Dwyer Attorney of Record Alanna C. Rutherford 333 Main Street Julia C. Hamilton Armonk, NY 10504 Laura Harris Telephone: (914) 749-8200 Ilana Miller Fax: (914) 749-8300 John Nicolaou Email: [email protected] Matthew R. Shahabian David L. Simons SKADDEN, ARPS, SLATE, MEAGHER & Craig Wenner FLOM LLP 575 Lexington Avenue John L. Gardiner New York, NY 10022 Four Times Square Telephone: (212) 446-2300 New York, NY 10036 Telephone: (212) 735-3000 Amy J. Mauser Abby Dennis R. Ryan Stoll William Bloom Gregory Bailey James A. Kraehenbuehl 155 N. Wacker Drive 5301 Wisconsin Avenue, NW Chicago, IL 60606 Washington, DC 20015 Telephone: (312) 407-0700 Telephone: (202) 237-2727 Attorneys for Starr International Company, Inc. February 19, 2015 and for the Plaintiff Classes Case 1:11-cv-00779-TCW Document 428 Filed 02/19/15 Page 2 of 573 TABLE OF CONTENTS 1.0 IN SEPTEMBER 2008, THE UNITED STATES FACED THE MOST SEVERE FINANCIAL CRISIS SINCE (AND PERHAPS INCLUDING) THE GREAT DEPRESSION. CREDIT MARKETS FROZE AND EVEN SOLVENT COMPANIES WERE UNABLE TO BORROW FROM PRIVATE SOURCES TO MEET THEIR LIQUIDITY NEEDS. ............................... 1 1.1 “September and October of 2008 Was the Worst Financial Crisis in Global History, Including the Great Depression.” (Bernanke: PTX 548 at 24; see also Bernanke: Trial Tr. 1959:8). ........................................................................... 1 2.0 THE FINANCIAL CRISIS OF 2008 THREATENED THE VIABILITY OF VIRTUALLY EVERY MAJOR FINANCIAL FIRM................................................... 2 2.1 In Financial Crises Even Solvent Companies Become Illiquid and Fail. ............... 2 2.2 In September 2008 Financial Markets Throughout the World Shut Down. ........... 3 2.3 In September 2008, Financial Markets Deteriorated and Money Market Funds “Began to Face Runs”. (PTX 708 at 90; Bernanke: Trial Tr. 1966:1-5). ................................................................................................................ 4 2.4 As Money Market Funds Began To Face Runs “They in Turn Began to Dump Commercial Paper as Quickly as They Could. As a Result, The Commercial Paper Market Went into Shock.” (PTX 708 at 90; accord Bernanke Trial Tr. 1966:1-5; Willumstad: Trial Tr. 6511:10-12). ......................... 4 2.5 Financial Institutions Stopped Lending to Each Other, Even on a Secured Basis. ....................................................................................................................... 4 2.6 During September 2008, “Even Companies That Were Solvent Were Not Able to Borrow the Liquidity That They Needed”. (Paulson: Trial Tr. 1204:3-5). ................................................................................................................ 4 2.7 In September 2008, the Financial Crisis and the Freezing of Credit Markets Threatened the Viability of Virtually Every Major Financial Institution. ............................................................................................................... 5 3.0 THERE WERE MANY CAUSES OF THE FINANCIAL CRISIS, WHICH HAD ITS ORIGIN IN AN OVER EXTENSION OF CREDIT BOTH BY TRADITIONAL BANKS AND BY THE ALTERNATIVE BANKING SYSTEM, PARTICULARLY IN THE HOUSING MARKET. ................................... 6 3.1 An Important Cause of the Financial Crisis Was That in the Years Prior to 2007 the Government Kept Interest Rates Artificially Low, Expressly in Part to Encourage Home Ownership, Which Resulted in the Over Extension of Credit and the Creation of a “Housing Bubble”. ............................... 6 i Case 1:11-cv-00779-TCW Document 428 Filed 02/19/15 Page 3 of 573 3.2 Another Important Cause of the Housing Bubble, and the “Housing Correction” That Followed Was “That for Many Years There Had Been Bad Lending Practices by Banks and Financial Institutions” and “Borrowers Had Been Taking out Mortgages That They Couldn’t Afford”. (Paulson: Trial Tr. 1198:23 – 1199:8). ................................................................... 7 3.3 Another Important Cause of the Financial Crisis Was the “Originate-to- Distribute” Business Model Adopted by Commercial Banks, Investment Banks, and Broker Dealers. .................................................................................... 7 3.3.1 Traditionally, lenders to homeowners (primarily banks and savings and loans) had an incentive to be sure the loans would be paid because they held the resulting mortgage. ............................... 7 3.3.2 Beginning in 2002 and accelerating in 2006 and 2007 mortgage originators would sell or transfer mortgages to a pool held by a special purpose vehicle (“SPV”). The SPV would in turn create a series or “tranches” of securities (collateralized debt obligations or “CDOs”) representing tiered rights to be paid from the revenue of the pool, which the SPV then marketed to investors and, in some cases, in part continued to hold. ....................... 7 3.3.3 The most senior CDO security or tranche had the right to be paid its principal and interest in full before any other CDO tranche received anything; the second most senior CDO tranche was then paid all of its principal and interest, and so on down the line. (Cragg: Trial Tr. 4956:1-22, 4958:15 – 4959:4). ......... 8 3.3.4 The originate-to-distribute business model substantially increased the investors in, and the money available to originate, housing loans. ....................................................................................... 8 3.3.5 The originate-to-distribute business model also eliminated the incentive of mortgage originators to be careful that their borrowers could repay the amounts loaned because the mortgage, and risk of non-payment, had been transferred to others. .................................................................................................... 9 3.4 Another Important Cause of the Financial Crisis Was That “Many of the Subprime Mortgages That Originated in the 2001 to 2005 Period Had Floating Rates”. (Saunders: Trial Tr. 8380:14-19). When the Federal Reserve Started to Raise Interest Rates in 2006 “the Cost of Meeting Mortgage Commitments Rose to Unsustainable Levels for Many Low Income Households”. (Saunders: Trial Tr. 8380:7-19). ........................................ 9 3.5 Another Important Cause of the Financial Crisis Was That Rating Agencies, upon Which Investors Relied to Evaluate the Riskiness of CDOs, Greatly Understated the Risks of Such Securities. ..................................... 9 ii Case 1:11-cv-00779-TCW Document 428 Filed 02/19/15 Page 4 of 573 3.5.1 In significant respects the rating agencies misled investors by fraudulently overstating the safety of CDOs and related securities. ............................................................................................ 10 3.6 Another Important Cause of the Financial Crisis Was the Collapse of the Alternative Banking System. ................................................................................ 11 3.6.1 In the years prior to 2007 an alternative or “shadow” banking system had developed which provided trillions of dollars of short-term liquidity to financial firms. ................................................ 11 3.6.2 The alternative banking system consisted primarily of investment banks and broker dealers that extended credit in competition with traditional banks. ..................................................... 11 3.6.3 An important element of the alternative banking system was the so-called “repo” financing which in March 2008 provided $4.5 trillion in financing, primarily to investment banks and broker dealers. ..................................................................................... 12 3.6.4 Repo financing was particularly vulnerable to a crisis of panic, loss of confidence, or uncertainty because it was overnight financing which had to be renewed every day. ................................... 12 3.6.5 The crash of the shadow banking system beginning in 2007 was an important cause of the liquidity crisis. .................................... 13 4.0 IN MARCH 2008, THE FEDERAL RESERVE SYSTEM RECOGNIZED THAT BECAUSE OF A LACK OF LIQUIDITY, “UNUSUAL AND EXIGENT CIRCUMSTANCES” EXISTED THAT JUSTIFIED IT FUNCTIONING AS A LENDER OF LAST RESORT TO COMPANIES OUTSIDE THE BANKING SYSTEM. ........................................................................ 14 4.1 The Crisis in Financial Markets “Arrived in Force on August 9, 2007”. (Paulson: PTX 706 at 78). .................................................................................... 14 4.2 Financial Markets Deteriorated Further from August 2007 to March 2008. ........ 14 4.3 In March 2008, the Federal Reserve Concluded That There Were “Unusual and Exigent Circumstances” Caused by “Frozen Markets” and a “Lack of Liquidity” in the Marketplace. ............................................................... 15 4.4 In March 2008, the Federal Reserve Concluded That Because of Its Role As the Lender of Last Resort and the Existence of “Unusual and Exigent Circumstances” It Would Lend Outside the Banking System. ............................. 15 4.4.1 On March 14, 2008, the Federal Reserve

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