The Housing Chronicles Blog: Launch of a new industry: mortgage-related lawsuits

Monday, March 3, 2008

Launch of a new industry: mortgage-related lawsuits

Like NASCAR entrants gunning their engines awaiting the green light, attorneys are gearing up for what could be one of the biggest legal paydays in history: the subprime debacle. From an L.A. Times story:

First came the sub-prime mortgage boom. Next was the bust. Now, as surely as day follows night, come the lawsuits.

All large-scale financial scandals spawn mountains of litigation, but the sub-prime fiasco stands out because of the complexity of the system that funneled more than $1 trillion from investors around the world through Wall Street and mortgage lenders to borrowers with dicey credit.

As losses mount on those loans, the scene of the blame game is shifting to the courts.

Sub-prime borrowers are suing loan brokers and lenders, accusing them of deceptive practices. Wall Street firms that bought now-delinquent sub-prime loans are trying to force lenders to buy them back.

Investment-bank shareholders are going after those firms' managers, saying they took excessive risks by loading up on bonds backed by sub-prime mortgages. And investors are suing money managers whose sub-prime-laden funds have suffered hefty losses...

In all, the 278 civil sub-prime-related cases filed in federal courts last year already amounted to half of the 559 actions brought during the entire savings-and-loan crisis from 1989 to 1995, according to research firm Navigant Consulting Inc...

The data don't include the unknown number of suits filed in state courts -- or the probes by federal and state regulators and prosecutors, who are bearing down on many of the key players in the mortgage industry, looking for evidence of wrongdoing.

The sub-prime meltdown is likely to overtake the S&L crisis as the civil litigation record-holder this year, Nielsen said...

In one novel case that began in January, the city of Cleveland sued 21 major banks under Ohio's public nuisance law, accusing them of reckless lending that is burdening the city with a mass of foreclosures...

Of course, as with most legal free-for-alls tied to financial blowups, most of those suing in the sub-prime mess aren't hoping to go to trial. The goal is compensation in an out-of-court agreement...

Some companies are bracing for possibly being on the hook for sizable settlements. State Street said recently that it would record a $618-million pre-tax loss to cover potential legal liability stemming from sub-prime losses in some of its investment funds.

Many homeowners who believe they were defrauded by sub-prime lenders, as well as small investors with related losses, are likely to end up in class-action lawsuits with hundreds or thousands of others.

Although participating in class actions saves the time and cost of pursuing cases individually, plaintiffs typically recover only pennies for each dollar of losses they allegedly incurred, legal experts note.

A wild card in the litigation frenzy is whether the numerous investigations by state and federal prosecutors turn up proof of wrongdoing that could bolster suits by investors, homeowners and others.

The Securities and Exchange Commission, the Justice Department, the FBI and many state attorneys general all are conducting sub-prime-related probes. Partly because companies feel compelled to cooperate with regulators, the government may have the best chance of uncovering incriminating evidence, experts said...

A key issue in many cases is sure to be whether the lenders and securities underwriters fully disclosed the risks to borrowers who took out sub-prime loans or to investors who bought securities backed by them...

The banks are likely to argue that sub-prime bonds were bought by sophisticated investors who understood the dangers and that it was impossible to foresee the turmoil that upended the housing market.

But if government regulators show that banks didn't adequately disclose the risks, it "would put this litigation into an entirely different and far more serious category," said Jonathan Macey, a securities-law professor at Yale University.

"That would take these from 'kind of improbable to win' to 'How many zeros are we talking about on the check?' "

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