The Inevitable Sub-Prime Lawsuits

Here come the inevitable lawsuits over the financial losses from the sub-prime mortgage shakeout.

UBS sued on sub-prime mis-selling

Germany's HSH Nordbank is to sue the Swiss banking giant UBS for mis-selling millions of dollars of investments linked to US sub-prime mortgages.
It wants to recover "significant" losses on a $500m (£253m) portfolio it bought in 2002.

HSH Nordbank alleges that UBS did not manage the assets in line with its "prudent investment objectives".

This will be a common theme in such lawsuits looking to recover these losses, i.e., did the asset manager use the "prudent person" standard when undertaking these investments (see definition at Answers.com).

This is a standard that a fiduciary must follow, making investment decisions that a prudent person would make in pursuit of normal returns and preserving capital, all relative to the risk assumed. In other words, while you don't just put everything in CD's or T-bills and go to sleep, you don't run to the race track with the dough, either.

If you violate this standard, without prior approval by the client, there can be personal liability by the fiduciary for the losses.

Being a fiduciary myself, I can tell you that this is a fairly broad standard, and a big issue will be what was disclosed to client and what did the client authorize be done? If the client was aware of the risk involved and either authorized the investments specifically or gave broad discretion to the fiduciary, it could be a tough go in court for the client.

I really doubt that the fiduciary's undertook these investments without proper signoff, but that is what courts are for to determine.

This will be a very interesting case to watch, I expect many more to be filed, but I also expect them to drag out in court for quite a while. Stay tuned and I will keep you updated as this progresses.

FBI Launches Sub-prime Investigation

The FBI is starting their investigation into the sub-prime lending mess. You are going to hear a lot about lending practices and defaulting loans.

Just remember, these really are two different issues, and confusing them will not lead to a solution.

The FBI is investigating 14 companies embroiled in the sub-prime mortgage crisis as part of a crackdown on improper lending.
It did not identify the companies but said the investigation encompassed developers, sub-prime lenders and investment banks.

FBI officials said the agency was looking at instances of accounting fraud and insider trading.

There very well may be some accounting fraud and other inappropriate activities in the lending industry. But I don't think it had much to do the sub-prime meltdown.

The sub-prime market is focused on providing home loans to those with poor or limited credit histories.

Many of these borrowers have been unable to keep up with payments and face losing their homes.

The wider crisis emerged as many of these mortgages were converted into financial instruments and sold on to investors including the big investment banks.

It is a cold, hard fact that at any given time there are only so many people in the mortgage market who can really afford a mortgage. Years ago, those unqualified mortgage applicants would have been turned down until they improved their financial situation.

But due to political correctness and "red-lining" laws, it has become almost impossible for lending institutions to deny those unqualified applicants today without getting sued for discrimination of one sort or another.

So, lending institutions have shifted to making the risky loans, and then packaging the mortgages into other instruments and selling them off to both avoid getting sued and unload the risky loan, all the while making some nice fee income off the deal.

It's like a bookie taking a risky wager and sloughing pieces of it off on other bookies to dump the risk (not that I would have any direct knowledge of such illegal wagering activity, you understand).

The public is looking for someone to blame now for this mess, so I expect to see some bank CEO's get drawn and quartered on TV in the near future. But if we are really interested in avoiding a repeat of this situation down the road, we have to allow lending institutions to turn down unqualified applicants without getting sued into oblivion.

Once those risky loans are made, it's just a matter of time until a large number of them default.