Many Americans still await the day Wall Street is held accountable for the financial crisis, and an end to “Nobody saw this coming” excuses.  A new report, Subprime Mortgage Crisis- Is 2013 Beginning or End?, examines the slow and certain process that some litigation has taken.

Yesterday, Bank of America reached an $11.7 billion agreement to get Fannie Mae off their backs.  This is part of roughly $50 billion that BoA has paid out in connection with Countrywide, the top originator of toxic loans during the scandal.  As the report details, BoA may have nefarious reasons for acquiring Countrywide, particularly as they are under fire for continuing Countrywide’s fraudulent “Hustle” lending program.  Fannie Mae, a taxpayer-subsidized program chartered by Congress, bought over $1.4 trillion in loans from BoA and Countrywide.  Thus, any fraud perpetrated on Fannie Mae has been perpetrated directly upon the American people.  Many others have pending lawsuits.

With statutes of limitations upon us, plaintiffs have finally discovered how to frame their arguments, judges have discovered the tip of a fraudulent iceberg, and many financial institutions have recognized that they should avoid a trial at all costs.  Some trials are already scheduled for 2013.  The payouts will come with spokespeople talking about “strengthening the economy” or things of that nature.  Much of the media and many of the politicians are in a challenging position of being subsidized by the firms that profited from these criminal activities, thus it remains to be seen if they continue to let the largest scandal in history simply fade away.

One of the groundbreaking discoveries in Rachel Carson’s best-selling book, Silent Spring,[1] is how mercury intensifies as it moves up the food chain.  From fish to bird to human, the toxicity increases.  Similarly, the impact of fraud intensifies as a bad mortgage moves along the investment chain, from broker to lender to investment bank to institutional investor, as “shitty deals” are consolidated, they create toxic failures of epic proportions.[2]

Toxicity in the mortgage sector once valued at $11 trillion was at the root of the 2008 financial collapse. This paper provides an overview of subprime litigation, focusing on the preliminary rulings over the past several years that have pointed to loan originators as the (very large) tip of a gigantic pyramid scheme.   Due to relevant statutes of limitations, the opportunity to pursue new litigation is receding.  Recent developments suggest an end is in sight.

EXECUTIVE SUMMARY

When the first subprime mortgage securities fraud cases were filed in the wake of the 2008 meltdown, few met the adequate particularity required for pleading fraudulent misrepresentations, omissions, and loss causation.  After being subjected to heightened pleading requirements by Rule 9(b) and the Private Securities Litigation Reform Act (PSLRA), courts sent plaintiffs’ counsel back to the drawing board.[3]  Subsequent amended complaints and new filings began to hone in on exactly how subprime lending operated, and what courts require to survive motions for dismissal and summary judgment.

Consolidation in the financial sector has both complicated and simplified the landscape.  For example, the world’s largest bank, Bank of America (BoA), bought the world’s largest loan originator, Countrywide.  As a result, BoA is the most highly-targeted subprime litigation defendant.[4]  Post-crisis mergers and acquisitions create fewer litigants, and more centralized control over discovery documents and settlement strategies.[5]  J.P. Morgan, who bought up Bear Stearns (the EMC Mortgage umbrella) and Washington Mutual, appear less willing to settle at the moment… but it remains to be seen how courts will rule on certain discovery motions.  Full disclosure regarding the subprime lending details may never be revealed.

Most allegations focus on mortgage originators’ disregard for underwriting standards, issuing high-interest loans to people with low (or no) income, and then providing representations and warranties that the mortgage backed securities (MBS) are fiscally sound investments.  Pension shareholders are suing their fund managers.  Fund managers are suing investment banks.  Investment banks are suing insurers.  Insurers are suing loan originators… and the losses trickle back upstream to the source.  The tide has turned in securities fraud actions, as it seems the “Nobody’s Fault” defense has been overruled by an “Everyone’s Fault” offense.

Mortgage insurers have had success against the lenders because of blatant violations of the written underwriting standards.  This indicates that investors might see similar results, except that showing a violation of these internal standards falls short of demonstrating fraudulent intent or gross recklessness.  Defendants who did not originate loans (such as trusts, investment banks and insurers) are in better position to shift blame, showing reliance on the reps and warranties of lenders.

Although not the earliest litigants into the fray, government actors have the potential to be the most effective plaintiffs.  The Federal Housing Finance Agency (FHFA), as conservator of Fannie Mae and Freddie Mac, has sixteen actions currently pending in the Southern District of New York.[6]  A recent ruling in the Southern District of NY, that FHFA has a credible theory of fraud, indicates few (if any) of the other FHFA cases will be dismissed at summary judgment.  A trial is scheduled with Deutsche Bank for September, 2014.  In that case, choice of law is highly contested, and the court ruled FHFA’s claims are viable under Virginia and District of Columbia law, as the jurisdictions host the headquarters of Freddie Mac and Fannie Mae, respectively.  Furthermore, the court also ruled the defendants will find no protection under New York’s Martin Act: although the Act creates no private right of action, it does not preclude it either.[7]  The FHFA case against Goldman Sachs has interpreted the Supreme Court’s holding in Janus (the person who “makes” a statement must have control over it) does not apply to state court, and there is no reason to believe that the Supreme Court’s holding will cause New York to retreat from its long-held position regarding the scope of common law fraud liability.[8]

Meanwhile, the various Federal Home Loan Banks have also filed a slew of actions in their jurisdictions.[9]  With support from the SEC and FDIC, they have the added impact of credibility before courts and legislators.  State Attorneys General are also involved with litigation on behalf of homeowners, as banks are accused both of “predatory lending” and allowing their massive stock of properties to fall into disrepair.

2013 is poised to become the most important year of the subprime aftermath.  The five year statute of repose, the window within which cases are arguably eligible under the Securities Act, will close.  Expect every potential plaintiff, including foreign investors and government entities, to fill the court dockets as precedent continues to be written.

Download the Full Report:  Subprime Mortgage Crisis- Is 2013 Beginning or End?

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Subprime Mortgage Crisis- Is 2013 Beginning or End?