Lawsuits Against Lenders Accelerate Amid U.S. Housing Crisis

The U.S. housing crisis has caused huge loan losses at big lenders but also spawned a slew of class-action lawsuits against them, many alleging noncompliance with consumer disclosure rules.

“The compliance issue is a ticking time bomb for some lenders,” said Louis Pizante, chief executive of Mavent Inc., an Irvine, California-based company that provides automated regulatory compliance reports for financial clients. “We have only just seen the beginning of the lawsuits.”

Navigant Consulting said in a report last month that in the 15 months through March 2008 a total of 448 lawsuits had been filed related to the subprime crisis. Of the 170 cases filed in January-March 2008, 46 percent were borrower class actions.

That compared to 559 lawsuits related to the U.S. savings and loan association debacle in the 1980s and 1990s, it said.

“Each of the top 10 subprime mortgage lenders for 2006 was named in at least one borrower class action suit during 2007,” the Navigant report said.

Lenders targeted include Wachovia Corp unit World Savings Bank, Bear Stearns Cos. Inc., Citigroup Inc.’s CitiMortgage, Wells Fargo & Co. Merrill Lynch & Co. Inc. unit First Franklin, and Countrywide Financial Corp., which agreed in January to be acquired by Bank of America Corp.

“Looking at the volume and scope of the claims, there is an all-out assault under way against the firms involved in subprime loans,” Navigant Managing Director Jeff Nielsen said.

Pizante and lawyers for plaintiffs said that if lenders lose such lawsuits, they may be obliged to return billions of dollars in interest and fees to borrowers. In some cases, homeowners could also have their loans declared unsecured debt by a bankruptcy court judge, allowing them to walk away.

Pizante said Mavent had seen a dramatic increase this year in requests for compliance checks from lenders. But requests have also risen from investors looking to verify whether the loans that Wall Street banks sold them during the height of the U.S. property boom met all applicable laws.

“In some cases it appears compliance may not have kept pace with the demand to get some of the more exotic loan products to market,” Pizante said.

Under a U.S. law known as The Truth in Lending Act, lenders must disclose the terms and cost of loans to consumers. But lawyers representing borrowers in the lawsuits claim lenders gave borrowers loans with hidden costs and consequences.

“The law requires lenders to disclose clearly and conspicuously what the ramifications are of a particular loan,” said Paul Kiesel, a partner at Kiesel, Boucher & Larson LLP.

“But in many cases they didn’t even come close,” he said.

Kiesel’s firm represents borrowers in more than 50 lawsuits involving Option Adjustable Rate Mortgages (ARMs), one of the more exotic loan products made available by lenders during the recent property boom.

Lawyers representing lenders said that compliance cases can often come down to the interpretation of a single word.

“This will be a long slog, but the industry will get through it,” said Tom Hefferon, a partner at law firm Goodwin Procter in Washington, D.C.

The stakes are high for lawyers and lenders. But emotions are running high for plaintiffs who had subprime loans.

Richard Carbone, 65, and his wife Carmen, 62, in Hesperia, California, are typical. They said that not only were they not protected but were cheated by their mortgage provider.

Carbone, a Vietnam War veteran, said in August 2006 a broker called and told him: “‘Have I got a great deal for you.”‘

The deal: refinancing his 30-year fixed rate mortgage to a loan charging only 2 percent annual interest.

Jeffrey Berns of Arbogast & Berns LLP, who is representing the Carbones and 12,000 other subprime borrowers in class action suits, said the Carbones ended up with an Option ARM with the terms not explained in the disclosures given.

“If I’d known what they were selling me, I would have stuck with my 30-year fixed loan,” Carbone said. “I was lied to.”

With an Option ARM, borrowers can make a minimum monthly payment instead of paying the larger full amount due. But the unpaid remainder is then added to the balance of the loan.

The loan interest starts at a low “teaser” rate, then goes up quickly. There are also stiff prepayment penalties.

In two months the Carbones’ interest rate went up and they found that $800 per month was being added to their balance.

“The average person would look at the deal as it was presented and think ‘this is great.”‘ Berns said. “But by the time they realize what they have, they can’t get out.”

“The disclosures for some Option ARMs state that ‘interest rates may go up,”‘ Kiesel said. “But in 100 percent of cases they went up in the second month. That’s misleading.”

Defense lawyers say that argument is unlikely to succeed.

“That is standard language on mortgage loan disclosures,” said Jeffrey Naimon, a partner at Buckley Kollar LLP in Washington, D.C. “Interest rates go up and down all the time, so this is not the world’s strongest argument.”

(Editing by Peter Bohan and Dave Zimmerman)