Advisen: lawsuits likely in subprime meltdown

A new report has been published detailing the meltdown of the US subprime market and how it will impact on the commercial insurance industry.

Advisen, authors of the report, issued the following briefing:

A rash of defaults by borrowers with tarnished credit histories under mortgages with built-in increases in monthly payments has sparked a crisis in the global financial markets.

Defaults in U.S. mortgages reached record levels in the second quarter of 2007, forcing a large number of subprime mortgage lenders to shut down or file for bankruptcy. The fallout spread quickly throughout the financial markets. Securities backed by subprime mortgages plummeted in value, leading to losses for investors in those instruments. In a few cases the losses were severe enough that highly leveraged hedge funds were forced to close when they couldn’t meet margin calls.

Virtually every party involved in the loan origination and securitization machine that financed the housing boom of the recent past is a potential target for lawsuits. Subprime lenders are the most obvious targets for securities class action suits and, to date, shareholders have filed suits against eleven mortgage lenders. Lenders also are targets of class action suits by borrowers, as well as suits by regulators, alleging “predatory” lending practices as regards subprime mortgages. Suits against creditors and business partners of failed subprime lenders alleging securities law violations are beginning to be filed. Other targets of suits filed so far include rating agencies, investment banks, and mortgage insurers.

There has not been an avalanche of suits to date, but D&O underwriters are cautiously eyeing the situation – attempting to assess not only how many and what types of suits are likely to be filed, but also the probability that those suits will produce insured losses and the potential magnitude of the settlements. However, forecasts concerning the impact of the subprime crisis on the D&O market at this early date are necessarily murky due to the complexity of the issues involved. The fact that there are numerous classes of stakeholders who are potential plaintiffs – borrowers, shareholders, investors in mortgage-backed securities, etc. – makes projections especially difficult. One potential wildcard is intervention by the federal or state governments – either in their regulatory and law enforcement roles, which could increase losses to D&O insurers, or through legislative actions to bail out troubled homeowners, which could help to reduce losses.