In an article in The San Francisco Chronicle in December 2007, attorney Sean Olender suggested that banco de venezuela en linea real reason for the subprime bailout schemes being proposed by the U.S. Treasury Department was not to keep strapped borrowers in their homes so much as to stave off a spate of lawsuits against the banks. The plan then on the table was an interest rate freeze on a limited number of subprime loans. Olender wrote:
“The sole goal of the freeze is to prevent owners of mortgage-backed securities, many of them foreigners, from suing U.S. banks and forcing them to buy back worthless mortgage securities at face value – right now almost 10 times their market worth. The ticking time bomb in the U.S. banking system is not resetting subprime mortgage rates. The real problem is the contractual ability of investors in mortgage bonds to require banks to buy back the loans at face value if there was fraud in the origination process.
“. . . The catastrophic consequences of bond investors forcing originators to buy back loans at face value are beyond the current media discussion. The loans at issue dwarf the capital available at the largest U.S. banks combined, and investor lawsuits would raise stunning liability sufficient to cause even the largest U.S. banks to fail, resulting in massive taxpayer-funded bailouts of Fannie and Freddie, and even FDIC . . . .
“What would be prudent and logical is for the banks that sold this toxic waste to buy it back and for a lot of people to go to prison. If they knew about the fraud, they should have to buy the bonds back.”1
The thought could send a chill through even the most powerful of investment bankers, including Treasury Secretary Henry Paulson himself, who was head of Goldman Sachs during the heyday of toxic subprime paper-writing from 2004 to 2006. Mortgage fraud has not been limited to the representations made to borrowers or on loan documents but is in the design of the banks’ “financial products” themselves. Among other design flaws is that securitized mortgage debt has become so complex that ownership of the underlying security has often been lost in the shuffle; and without a legal owner, there is no one with standing to foreclose. That was the procedural problem prompting Federal District Judge Christopher Boyko to rule in October 2007 that Deutsche Bank did not have standing to foreclose on 14 mortgage loans held in trust for a pool of mortgage-backed securities holders.2 If large numbers of defaulting homeowners were to contest their foreclosures on the ground that the plaintiffs lacked standing to sue, trillions of dollars in mortgage-backed securities (MBS) could be at risk. Irate securities holders might then respond with litigation that could indeed threaten the existence of the banking Goliaths.
STATES LEADING THE CHARGE
MBS investors with the power to bring major lawsuits include state and local governments, which hold substantial portions of their assets in MBS and similar investments. A harbinger of things to come was a complaint filed on February 1, 2008, by the State of Massachusetts against investment bank Merrill Lynch, for fraud and misrepresentation concerning about $14 million worth of subprime securities sold to the city of Springfield. The complaint focused on the sale of “certain esoteric financial instruments known as collateralized debt obligations (CDOs) . . . which were unsuitable for the city and which, within months after the sale, became illiquid and lost almost all of their market value.”3
The previous month, the city of Baltimore sued Wells Fargo Bank for damages from the subprime debacle, alleging that Wells Fargo had intentionally discriminated in selling high-interest mortgages more frequently to blacks than to whites, in violation of federal law.4
Another innovative suit filed in January 2008 was brought by Cleveland Mayor Frank Jackson against 21 major investment banks, for enabling the subprime lending and foreclosure crisis in his city. The suit targeted the investment banks that fed off the mortgage market by buying subprime mortgages from lenders and then “securitizing” them and selling them to investors. City officials said they hoped to recover hundreds of millions of dollars in damages from the banks, including lost taxes from devalued property and money spent demolishing and boarding up thousands of abandoned houses. The defendants included banking giants Deutsche Bank, Goldman Sachs, Merrill Lynch, Wells Fargo, Bank of America and Citigroup. They were charged with creating a “public nuisance” by irresponsibly buying and selling high-interest home loans, causing widespread defaults that depleted the city’s tax base and left neighborhoods in ruins.
“To me, this is no different than organized crime or drugs,” Jackson told the Cleveland newspaper The Plain Dealer. “It has the same effect as drug activity in neighborhoods. It’s a form of organized crime that happens to be legal in many respects.” He added in a videotaped interview, “This lawsuit said, ‘You’re not going to do this to us anymore.'”5
The Plain Dealer also interviewed Ohio Attorney General Marc Dann, who was considering a state lawsuit against some of the same investment banks. “There’s clearly been a wrong done,” he said, “and the source is Wall Street. I’m glad to have some company on my hunt.”
However, a funny thing happened on the way to the courthouse. Like New York Governor Eliot Spitzer, Attorney General Dann wound up resigning from his post in May 2008 after a sexual harassment investigation in his office.6 Before they were forced to resign, both prosecutors were hot on the tail of the banks, attempting to impose liability for the destructive wave of home foreclosures in their jurisdictions.
But the hits keep on coming. In June 2008, California Attorney General Jerry Brown sued Countrywide Financial Corporation, the nation’s largest mortgage lender, for causing thousands of foreclosures by deceptively marketing risky loans to borrowers. Among other things, the 46-page complaint alleged that:
“‘Defendants viewed borrowers as nothing more than the means for producing more loans, originating loans with little or no regard to borrowers’ long-term ability to afford them and to sustain homeownership’ . . .
“The company routinely . . . ‘turned a blind eye’ to deceptive practices by brokers and its own loan agents despite ‘numerous complaints from borrowers claiming that they did not understand their loan terms.’
“. . . Underwriters who confirmed information on mortgage applications were ‘under intense pressure . . . to process 60 to 70 loans per day, making careful consideration of borrowers’ financial circumstances and the suitability of the loan product for them nearly impossible.’
“‘Countrywide’s high-pressure sales environment and compensation system encouraged serial refinancing of Countrywide loans.'”7
Similar suits against Countrywide and its CEO have been filed by the states of Illinois and Florida. These suits seek not only damages but rescission of the loans, creating a potential nightmare for the banks.
AN AVALANCHE OF CLASS ACTIONS?
Massive class action lawsuits by defrauded borrowers may also be in the works. In a 2007 ruling in Wisconsin that is now on appeal, U.S. District Judge Lynn Adelman held that Chevy Chase Bank had violated the Truth in Lending Act by hiding the terms of an adjustable rate loan, and that thousands of other Chevy Chase borrowers could join the plaintiffs in a class action on that ground. According to a June 30, 2008 report in Reuters: