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Home > Blogs > Anthony Harrington > Court actions see subprime carelessness coming home to roost

Court actions see subprime carelessness coming home to roost

Finance Blogger: Anthony Harrington Anthony Harrington

In most kinds of business, if I sell you a product that is completely unfit for purpose, you’ll be able to sue me without much difficulty and with a pretty high expectation of success. Now it seems that some of the institutions who found themselves on the losing end of US subprime mortgage securitizations want this same standard of commercial logic to apply to transactions in which, by most accounts, no one, including the losers, did anything remotely resembling due diligence.

A spate of actions are now before the US courts and in many instances the plaintiffs are companies who specialize in insuring residential mortgage-backed securitizations, and who got hammered when the securitizations failed to deliver. A cursory common sense judgment might start from the point of view that someone who takes a premium for guaranteeing a securitization, and who doesn’t bother to unwrap the securitization even partially, in order to acquaint themselves with the quality of the loans involved, is asking for trouble.

Going to the court for redress when the deal goes pear shaped is kind of like using the judge as your post event substitute for pre-deal due diligence. Again, a common sense view of things might not expect the courts to be too favorable to such actions.

However, as the New York Times Chief Financial Correspondent Floyd Norris observes, the plaintiffs are getting a favorable hearing from some US judges.

“You can make a case — call it the caveat emptor case — that no one should be able to recover any losses they suffered from loans that went bad. If they had performed even rudimentary checks before the loans were made, sold, rated, insured or securitized, it’s very likely that big problems would have been visible before disaster hit. There would have been fewer bad loans and many fewer foreclosures. That case is not, however, showing any sign of prevailing as legal battles increase in number. Instead, it appears that big banks will be compelled to pay for their own sins as well as the sins of others.”

Few will feel disposed to waste any sympathy on the banks who are being forced to repurchase mortgages that they sold off in these securitised tranches, but it is odd that organizations like Fannie Mae and Freddie Mac, which bought the mortgages without the tiniest bit of due care, simply relying on the word of the seller, aren’t getting their knuckles rapped as well.

Norris points out that monoline insurers such as MBIA and Ambac, who made fortunes insuring these securitized bundles of rubbish against default, again without due checks, are also being reasonably successful in getting banks to cough up. As MBIA puts it in its Q2 2010 financial statement, more and more banks are recognizing that these securitized products contained loans that should never have been part of the securitized deal – and by reimbursing the likes of MBIA they are owning up to their shortcomings.

MBIA’s case is that it relied on the representations and warranties as to the good value of the securities made by the banks and brokerage firms when they bought insurance from it. According to Norris, MBIA further argues that if it had had to do the due diligence itself then it would have had to charge much more for the insurance cover it provided. The answer to this, surely, is that if it and the other insurers had done the work they should have done, and charged more for doing it, that might have put a salutary break on the outflow of dodgy mortgage-backed securitizations and the crash might not have been so deep or so disastrous.

Further reading on the subprime roots of the crash



Tags: banking , Fannie Mae , financial crisis , Freddie Mac , MBIA , subprime
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