FinCri Advisor advises us that the recent federal district judge's dismissal of a lawsuit brought by the city of Cleveland against banks and investment banks (which we discussed last week) is no cause for celebration by the defendants. In the first place, as we noted last week, Cleveland is appealing the dismissal and vows to fight until the last breath of the last municipal taxpayer left standing, and also has a related lawsuit pending in state court (although Buffalo's suit suffered a setback a few months ago). Moreover, Baltimore, Birmingham and Buffalo still have ongoing litigation against banks and Shelby County, Mississippi and Atlanta are reportedly gearing up to jump on the dog pile. Some litigators who've been defending banks in these lawsuits believe that more are on the way, and whether or not the claims will be ultimately successful, the cost to banks will be substantial.
"Think of the potential number of jurisdictions that can bring these claims," notes attorney Richard E. Gottlieb, head of the Financial Institutions and Insurance group for Dykema in Chicago, who represented IndyMac in the Cleveland case and NationsBank in Buffalo.
Even if the claims have no merit, Gottlieb says banks still can end up spending a lot of money defending them. "I will expect a lot more of these lawsuits," he says. "My guess is that the public nuisance claim is the most logical for cities to file under. It is the one that has the greatest potential appeal for holding lenders liable."
It's also one that might resonate with voters in the municipalities that have brought claims thus far. Most of those cities have been in decline for some time prior to the subprime mortgage mess, but the recent meltdown has exacerbated the misery of those municipalities and, at the same time, offered the failed leadership a convenient scapegoat.
Another litigator disagrees with Mr. Gottlieb.
But Skadden partner Joseph Barloon in Washington, D.C. isn't so sure. "I think this will make municipalities think twice before filing copycat lawsuits," he says. "That's a good thing for the banks."
Mr. Barloon assumes that local politicians can think once, much less multiple times. I'm not certain that assumption is correct. Mr. Barloon's firm, the well-known Skadden Arps, has analyzed the issues and suggested several possible approaches that municipalities might use to survive a motion to dismiss.
In a May 15 memorandum, Skadden attorneys suggest that "the decision may lead municipalities and other entities pursuing similar claims to allege that the defendants violated one or more laws or regulations, in order to distinguish their case from City of Cleveland and survive a motion to dismiss." The memo also notes that the decision "will give financial institutions facing ‘subprime meltdown' litigation significant support in setting forth preemption and causation defenses."
Gottlieb advises banks not "to be overly optimistic as a result of Judge Lioi's opinion." Still, he says, "judges tend to operate in packs." So "if you get a second or a third decision favorable to the industry, you might see the end of these cases."
Mr. Gottlieb and one of his partners, Andrew McGuinness, wrote more extensively last summer in the American Bar Association's Business Law Today on the different legal theories being pursued by the municipalities. Inasmuch as these gentlemen represent banks involved in this litigation, you might suppose that they're skeptical about the advisability of municipalities pursuing these types of suits. Your supposition would be correct. With that natural bias in mind, however, they touch on what they call "a paradox wrapped in a paradox" that rests at the heart of these lawsuits, regardless of the legal theory being employed to sue banks.
One of the central contradictions of these cases is that banks are essentially being sued for making credit available to high-risk inner-city borrowers, thereby allowing numerous otherwise underserved consumers to achieve or maintain the American dream of home ownership. Another, related, paradox is that essential market-based features of these riskier loans that allowed them to materialize—higher fees and interest rates to compensate for the increased risk of default—themselves increased their cost by making the loans less "affordable" and thereby more likely to result in such default.
The city lawsuits focus more on the effects, that is, foreclosures and abandoned homes. They point to these foreclosures and ask the court (or jury) to conclude—based largely on the fact of the foreclosures themselves—that the banks acted improperly, even "unscrupulously" and "irresponsibly." The irony is that no bank wants a foreclosure. A foreclosure represents a failed loan and, typically, huge bank losses. This is even more manifestly the case when the foreclosed property remains vacant (the alleged public nuisance). Every vacant home resulting from a foreclosure that a city claims is blighting its neighborhoods represents not just a bad loan but an unsuccessful foreclosure as well. Are the cities pointing at these manifestations of failed loans and demanding one more ounce of flesh from a reeling industry? Or are these vacant homes the most conspicuous examples of irresponsible lending?
As is usually the case whenever litigation is used to pursue purely political goals, logic and sound business rationales are irrelevant. All that matters is the political spin. The cities are suing banks for the same reason that Willie Sutton said he robbed them: "Because that's where the money is."
For legal geeks interested in parsing the nuances of these legal claims, the article is a good summary. To me, Messrs. Gottlieb and McGuinness seem even more insightful in their analysis of the expected results of all this litigation. In their view, even if the cities win (which, I assume, they don't believe is the most likely outcome), they'll lose.
[I]f successful, these lawsuits may ultimately do more long-term harm than good. The cities hope to reap hundreds of millions of dollars from the banks to reimburse them for a diminished real estate tax base resulting from foreclosures. But lenders should logically be entitled to an offset for the higher tax revenues collected by cities for years that, according to the logic implicit in their complaints, were associated with the now-challenged lending practices. And if banks stop making loans in urban areas to avoid exposure, the property tax base in these inner cities will be devastated. And how will poorer city residents buy houses then?
Let me think...hmmm...I got it. The cities will offer tax and other incentives, as well as as much public jawboning and whining as possible, to induce/force lenders to make mortgage loans to those who can't afford to repay them.