2008 Legal Opportunities From The Subprime Mess

January 2008

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The biggest financial story of 2007 was subprime loans. “Subprime” loans are non-traditional, higher-risk loans carrying higher interest rates and made to buyers who cannot qualify for traditional loans. Subprime loans include mortgages with low initial “teaser” interest rates that increase significantly after two or three years, zero-down loans, variable-interest-rate loans, and stated-income loans requiring little or no income documentation. In recent years, many buyers used subprime loans to purchase homes they could not otherwise afford.

Estimates of losses associated with subprime loans already exceed $100 billion. Subprime loans may be the biggest legal story in 2008, as everyone facing these large losses will seek to reallocate the losses to others.

Subprime loans create a variety of claims

The large subprime lending losses has already spawned considerable litigation, and more is sure to follow. Some law firms have created special practice groups or task forces to address this cornucopia of new work. Some of the major areas of litigation include:

1. Class action lawsuits by the shareholders and public bondholders of the subprime lenders - 2007 class action new filings associated with the subprime lending mess increased filings by 58 percent from 2006 levels, according to a study published by NERA Economic Consulting.

2. Suits against the subprime lenders and underwriters of the securitized loans by institutional investors who have lost money on what they have purchased. These suits can claim breaches of contract, breaches of warranty, or misrepresentations associated with what was sold/purchased.

3. Suits directed at available directors and officers insurance policies, claiming various breaches of fiduciary duties

4. Suits against subprime lenders by state and federal regulators regarding (i) misrepresentations to (ii) investors, and (iii) borrowers

5. Suits by borrowers who have lost their homes - Borrowers will allege that the lenders (i) failed to disclose, or actively misrepresented, the terms and risks of these loans, and/or (ii) engaged in predatory practices by providing loans that were not suitable for the borrowers’ financial circumstances

6. Suits against underwriters, law firms, accounting firms, and other professional advisors involved with the securitization process. These suits will allege malpractice, or various scheme or conspiracy theories

7. Suits against rating agencies - Investment banks securitized and sold bonds backed by subprime mortgages based on an investment-grade rating for the bonds. Ratings agencies will face allegations similar to the underwriters.

8. Suits against mortgage brokers, real estate agents, title companies, appraisers, and others that are involved in the lending process - These suits will be brought by anyone facing a loss on the underlying individual loans.

9. Suits by retirement plans that invested in company stock of the subprime lenders and homebuilders – Like all suits involving retirement plans that hold their sponsor’s stock, the suits will claim the company stock was not a prudent investment.

10. Bankruptcy work for subprime lenders and weaker home builders

Damages Causation will be Critical Issue

An important issue in many of these cases involves damage causation. Consider:

1. Was damage caused by the deal itself, or was the loss caused by something external to the deal?

2. Was the damage caused by a weakening real estate market that cannot be tied to the loan transaction?

Fulcrum Inquiry is a forensic accounting and appraisal firm that regularly performs damages analysis in litigation.