State attorneys general are stepping up the legal pressure on the mortgage industry, but it is unclear whether their response to the subprime market fallout will actually lead to a glut of lawsuits.
At the forefront of the legal battle against the industry has been Marc Dann, attorney general for Ohio, who has sued more than a dozen lenders and brokers for allegedly engaging in various unscrupulous practices against borrowers. "I'm committed to ridding this state of appraisal inflation and other symptoms of mortgage fraud that has ripped families apart and led to an unprecedented number of foreclosures in this state," Dann said in a statement in June.
Ohio has had the highest rate of foreclosures in the country over the past two years, according to the Mortgage Banker's Association. Approximately 3.3% of the state's loans are in the process of foreclosure, about three times the national average.
Massachusetts Attorney General Martha Coakley is the latest AG to take legal action, filing a lawsuit on Oct. 5 against Fremont General Corp., which originated thousands of loans in the state. The complaint alleges that the California-based subprime lender "engaged in unfair and deceptive conduct on a broad scale in connection with selling mortgage loans to Massachusetts consumers."
Fremont General responded to the complaint by issuing a statement saying it is working with regulators to help delinquent borrowers "through loan modifications and other productive measures" and claimed the lawsuit is without merit. "The company finds it regrettable that the Massachusetts Attorney General has abandoned these cooperative efforts to help borrowers keep their homes," the statement said. Fremont stopped making subprime loans in March.
Legal experts question how successful states will be in lawsuits against the mortgage industry. Ron Berenstain, a partner at Perkins Coie and co-chair of the firm's securities & corporate governance litigation practice, noted that state attorneys general must develop a damage theory that proves widespread foreclosures would harm a neighborhood. "They would have to prove that the state is damaged if a lot of people are put out of their homes," said Berenstain.
But the challenge in a class-action lawsuit, added Berenstain, is demonstrating that a large group of borrowers was actually defrauded. In other words, were the borrowers victims of actual fraud, or did they just engage in a bad business deal? "You have to prove whether or not there is some kind of widespread foreclosure and whether this actually constitutes fraud," he said. "Everybody's deal is a different transaction. How are you going to prove whose fault it is?"
James Tierney, former state attorney general for Maine and the director of the National State Attorneys General Program for Columbia Law School, believes that the AGs most important role for now will likely not be in the courtroom. "AGs have to prosecute fraud, but that responsibility in this case is, in my judgment, trumped by some broader responsibilities," he said. "There's no shortage of fraud in this area, but that's not going to keep people in their homes."
Public outreach will be critical for state attorneys general as they wade through the mess of foreclosures, according to Tierney. At an AG summit in Chicago last July addressing the subprime foreclosure crisis, it was determined that the majority of people facing foreclosure has never even called their banks. "There are some people who could get some help through modifications but are not taking advantage of it," said Tierney.
Iowa State Attorney General Tom Miller launched a "Mortgage Foreclosure Project" last month that includes a hotline for borrowers to call to see if they are eligible for a loan modification. "The AGs are being pretty careful about suing people here," said Tierney. "There's not a shortage of fraud, but they don't want to dry up capital in litigation that could always go toward helping people."
Tierney noted, however, that state attorneys general had been aggressive in prosecuting mortgage companies long before the current subprime crisis spread. Household International Inc., now HSBC Finance Corp., settled for $484 million in 2002, while Ameriquest Mortgage settled for $325 million in 2005. Iowa State Attorney General Miller led the prosecution in both cases. "States have been involved in this for a long time and have brought some major cases," said Tierney. "They're the only people who really have. The federal government did not because there was too much money being made along the way."
While state attorneys general have been at the forefront of legal action against the mortgage industry in recent years, the bulk of lawsuits will likely now come, not from the states, but from investors, according to Berenstain. "That's where the biggest losses have happened," he said.
On Oct. 17 it was reported that Texas billionaire Gerald Ford was backing out of a proposed $80 million takeover of Fremont General Corp., the California lender being sued by Massachusetts. In response, Amalgamated Gadget LP, which owns an 8.3% share in Fremont, demanded the company put itself up for auction. Investor Geoffrey Raynor, who controls Amalgamated's shares, has threatened a lawsuit to block any deal negotiated behind closed doors.
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