Amid the subprime mortgage crisis, many people across the country-with both good and bad credit-have found themselves stuck with loans that are not what they anticipated. Mortgage lenders and related institutions are under intensifying scrutiny for a wide range of illegal conduct, including misrepresenting loan terms, adding bogus fees, inflating appraisals, committing securities fraud, and discriminating against borrowers based on their race and gender. Lawsuits allege violations of the Truth in Lending Act (TILA), the Fair Housing Act, the RICO statute, and state consumer protection laws, to name a few.
Last year, 278 subprime-mortgage-related cases were filed in federal court-with the number in the second half of the year nearly twice the number in the first half-and that figure is likely to continue growing, according to a report by Navigant Consulting. Forty-three percent of those cases were borrower class actions, most involving inadequate disclosure regarding option adjustable-rate mortgages (ARMs) and discriminatory lending practices.
The option ARM has proved especially problematic. “It’s a subprime product being marketed to everybody,” said Jeffrey Berns, a Tarzana, California, lawyer, whose firm has filed 60 federal class actions against major lenders over option ARMs. He noted that these clients range “from doctors and lawyers to field workers.”
Option ARMs have adjustable interest rates and different monthly payment options. For example, the monthly payment may be fixed for the first few years, but the interest rate goes up beginning in the second month. At that point, the interest being charged exceeds the payment amount, so the difference is added to the principal owed-a process called negative amortization. Many borrowers then owe more than they thought they would.
“A significant number of people had better loans before getting talked into these option ARMs,” Berns said. The loan documents often say that the low initial rate may increase, but some documents contain “statements that are outright lies,” he said.
Paul Kiesel, a Beverly Hills, California, lawyer, also represents borrowers suing over option ARMs. His firm has filed 56 class actions, most of which revolve around TILA violations, all on behalf of borrowers who stand to lose their primary residences. He estimated that half had loans with low interest rates before signing up for the option ARMs. “They were eligible for far better mortgages than they got,” he said.
If the terms are not adequately disclosed, a mortgage is rescindable, but the general public may not be aware of that, Kiesel said. He and his colleagues have built a consortium of firms to work together-which is necessary because “we have taken on the largest lenders in the United States, and they have unlimited resources,” he said. “We are facing such an imminent threat” of people being forced out of their homes that lawyers have a responsibility to take on this type of litigation.
“It’s too early to get a sense of the direction” the litigation will take, Kiesel said. He noted that some cases are proceeding individually, but on a limited basis, “and those cases are tough.”
Berns said that lawyers bringing class actions are now dealing with motions to dismiss, as defendants argue for federal preemption of state law (some cases allege fraud and breach of contract under state law). Plaintiffs in these cases are likely to move for class certification this summer, he said.
The Seventh Circuit is set to decide whether to certify a class in a case brought by a couple who sued their lender for inadequately disclosing the terms of their option ARM. (Andrews v. Chevy Chase Bank, No. 07-1326 (7th Cir. argued Sept. 26, 2007).)
“This is the first case in which a circuit court has considered an option ARM,” said Milwaukee lawyer Kevin Demet, who-along with his brother Donal Demet-represents the plaintiffs.
A federal district court found in the plaintiffs’ favor and certified the lawsuit as a class action, and Chevy Chase Bank appealed. Bryan and Susan Andrews previously had a stable loan but were lured into refinancing by “essentially fake low payments,” said Donal. Borrowers often don’t realize that the loan goes into negative amortization in its second month, he said.
“The problem is coming to a head now” because many of these loans are reaching the point where the payment is recalculated after a low, fixed rate for the first few years, Donal explained. “Now is when they’re hitting the crisis stage.” He added that Chevy Chase indicated it had about 8,000 of these loans with the same type of disclosure.
“This case is significant because the mortgage banking industry attempted to get Congress to ban class actions for rescission of mortgages in 1995,” Kevin explained. “Congress gave the industry greater tolerance for errors in TILA disclosures, but Congress declined to enact the ban. Nevertheless, the industry has been filing briefs in court suggesting that Congress adopted the ban.”
Class actions would better enable borrowers who have been misled to get meaningful relief, plaintiff lawyers say.
Some areas of the country have seen companies prey specifically on borrowers who do not qualify for prime loans, lawyers say. Lawsuits have accused lenders and brokers of targeting groups that they perceive to be financially unsophisticated, such as low-income and minority borrowers.
The problem is acute in Cleveland, where foreclosure rates are among the highest in the country. Cleveland lawyer Edward Kramer and his firm have more than 25 cases pending over predatory-lending practices, most arising from foreclosure actions.
The traditional mortgage system “wasn’t working for the poor or minority communities,” Kramer said, and that left the door open for mortgage brokers to target vulnerable people. In some cases, brokers looked for property owners cited for building code violations (to identify people ordered to repair their homes or face prosecution) and bought lists of people with delinquent hospital bills. “Both groups needed quick money, so they could be tricked to enter these predatory loan agreements,” he said.
“Many clients are unsophisticated-that’s part of the problem,” Kramer said. “Mortgage brokers fill out the applications 95 percent of the time.” He added that in some cases, brokers actually gave borrowers money to make their financial situation appear better than it was.
“We’re looking at a real fraud” that’s built into the companies’ business models, Kramer said, “from Wall Street down to the street soldiers, who are the mortgage brokers.” He added that “on an individual basis, these cases have been very successful.”
One case alleged that a lender and its agents engaged in predatory and discriminatory practices by targeting women in the Cleveland area.
“Defendants extract unconscionable and illegal fees from their victims until there is no money left to extract; they then leave their victims’ homes vulnerable to foreclosures, which the loans were specifically designed to facilitate,” the complaint says. (Eva v. Midwest Natl. Mortg. Banc, Inc., No. 1:00CV1918 (N.D. Ohio filed July 27, 2000).)
The plaintiffs alleged that the defendants failed to explain the loans’ basic terms, made little or no effort to verify the applicants’ ability to repay their loans, falsified applications, and conspired to give kickbacks to other corporations-violating RICO, the Fair Housing Act, Ohio antidiscrimination law, the Equal Credit Opportunity Act, and TILA. The parties settled the case, and seven out of eight homes were saved.
More recently, the Cleveland-based public-interest law firm Housing Advocates, Inc., which Kramer directs, filed a complaint with the Ohio Civil Rights Commission against Argent Mortgage Co. for racial discrimination, claiming that the company offered loans that were likely to result in foreclosure in mostly African-American neighborhoods. The commission investigated and found that the evidence substantiated the alleged discrimination claim. (Housing Advocates, Inc. v. Argent Mortgage Co., (CLE)H4(38066)05212007, 05-07-0938-8 (Ohio Civ. Rights Commn. Mar. 13, 2008).) A hearing is to follow.
Municipalities themselves have sued lenders and related companies, saying they have lost money protecting or demolishing foreclosed homes and through lost tax revenue. Baltimore has sued Wells Fargo Bank for predatory lending in black neighborhoods. Cleveland has sued 21 Wall Street banks under state public-nuisance law for funding the lenders who engaged in predatory lending.
The complexity of mortgage securitization-determining which company is doing what-makes things difficult for plaintiffs, Kramer said, because “no one’s taking personal responsibility.”
A former regional vice president of Countrywide Financial Corp., the nation’s largest lender, has sued the company for firing him after he pointed out its fraudulent practices. (Zachary v. Countrywide Fin. Corp., No. 4:2008cv00214 (S.D. Tex. filed Jan. 17, 2008).)
Mark Zachary discovered that appraisers were being encouraged to inflate homes’ values; loan officers were helping borrowers submit applications with false information; and Countrywide was requiring 10 percent of its backlogged applications to be approved so that a builder could start building homes under contract, even though the applicants were not qualified. These were systemic company practices, said Philip Hilder, a Houston lawyer who represents Zachary.
“Mark signaled the alarm that these practices shouldn’t go on,” he said. The company fired him two weeks later.
Zachary sued for wrongful discharge and filed a whistleblower retaliation complaint with the U.S. Department of Labor. His case serves as “a snapshot of what is happening in the industry,” Hilder said. “It exposes the root cause of what has led to the subprime debacle.”
Countrywide’s practices have raised concern elsewhere. The U.S. trustee for Florida has filed suit in bankruptcy court against the company for “bad-faith conduct that abused the judicial process.” The case seeks sanctions and injunctive relief. (Walton v. Countrywide Home Loans, Inc., No. 08-6092 (Bankr. N.D. Ga. filed Feb. 28, 2008).)
The complaint cites bankruptcy courts in North Carolina, Pennsylvania, and Texas that have sanctioned Countrywide or its representatives for their conduct. U.S. trustees in Ohio and Florida have filed similar complaints. The Florida attorney general is investigating the company’s business practices.
The Justice Department and the FBI are investigating Countrywide for securities fraud, and both agencies are taking a closer look at the rest of the mortgage industry as well. The Justice Department is gathering evidence to decide whether to create a special task force to investigate possible wrongdoing, and the FBI is investigating 17 firms for fraud.
Lenders also face lawsuits from shareholders, employees (alleging that they were denied overtime pay or terminated without the requisite advance notice, for example), and homeowners who say they have been hurt by inflated home appraisals in their neighborhoods.
Kramer pointed to greed as the reason the subprime problem has grown to its current proportions. Lenders have cut corners, and commercial banks have agreed not to require verification of income, he said.
Berns said his office has taken more than 14,000 calls from homeowners. “Not a day goes by that we don’t get a call from someone losing their house,” he said.
“It’s not an easy situation,” Kramer said, but “if we could get lawyers to take a case or two, we could have a tremendous impact in the community.
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