Banking Law

According to today's The Wall Street Journal, the subprime crisis is sweeping a lot of elderly investors down the drain, many of whom didn't realize that they were investing in the subprime mortgage market. Instead, they thought they'd been sprinkled with fairy dust and entered the magic kingdom where interest rates are always impossibly high and risk never rears its ugly head.

Until a few weeks ago, Sonia Deravedisian had never heard of the subprime-mortgage market. Nevertheless, she lost her life savings because of it.

The $55,000 she saved over 35 years as a self-employed tailor is gone. Ms. Deravedisian, now 74 and disabled, is one of the earliest victims of the mortgage crisis, in a case that has drawn the attention of federal investigators over the role some of the biggest names on Wall Street may have played.

She and 22,000 other people, many elderly, lost about $750 million when a Philadelphia lender called American Business Financial Services Inc. went bankrupt three years ago. ABFS had funded its operation partly by selling notes directly to the public, pitching them in newspaper ads and mass mailings that promised high interest rates. When it went under, these notes, which carried no collateral and weren't insured, became worthless.

Now a bankruptcy trustee is trying to recover money from the investment banks that turned the lender's loans into securities. His claim: They helped keep the lender alive -- and paying them fees -- by enabling it to overstate the value of assets on its books.

When your primary defendant fails, you look for other potential defendants with deep pockets. What else is new? The trustee is doing what so many have done before: try to get the financial institutions with big bucks to cough up a hefty settlement as a cost of doing business. According to The WSJ, the trustee is picking on many of the usual suspects: Bear Stearns, J.P. Morgan Chase, Morgan Stanley and Credit Suisse. Those banks will keep their lawyers busy for the next few years fighting these claims. A number of large Wall Street law firms are, as we speak, casting legions of paralegals and young associates into the billable hour fires to burn in the hell-like torture of document parsing and deposition indexing until their brains fry and the partners' wives can all afford a new pair of new Angelina-Jolie-like bee lips.

There are a couple of interesting twists. The trustee has drawn in the FBI and the SEC. Sounds like a three front war for the investment banks, doesn't it? The enemy of my enemy is my friend, eh? This case also presents us with another class of victims: investors, many, if not most, elderly, who chased a yield that seemed too good to be true because it was, and who failed to read the prospectuses provided to them (one with eighteen pages of risk factors) because they were too long and/or contained too much "mumbo jumbo." Typical is Virgil Magnon, 81 years old and out a cool $761,000.

"Small investors like me are not very savvy," says the retired aerospace contract administrator. "My primary interest in investing was to raise enough money for catastrophic medical problems down the line. You could call that greed, but I don't think it's greed. It's trying to get more for your money."

It might also be called stupidity, venality, gullibility, or a number of other things. Every con man who runs a successful "grift" knows that he can't make it work without appealing to the baser instincts of the "mark," whose desire for "something for nothing" blinds him to the risk.

Here's the kind of yield that victims like Virgil were chasing:

"Found: a 24 month investment opportunity yielding 9.14% annually," said a mass mailing from ABFS dated Nov. 14, 2001. At the time, two-year Treasury notes paid about 3%. ABFS's ads touted interest rates of more than 12%.

The yield is over three times that of a comparable Treasury note. That's not just a red flag, that's a red flag the size of Christo's wrapping of the Reichstag. Yet, people just piled on to devour this garbage.

I'm not defending any of the defendants, certainly not ABFS. If there was wrongdoing, then it will likely come out in the wash, inasmuch as there appears to be a veritable army of eyeballs scoping out every nook and cranny of potential liability. The guilty should pay for their transgressions. I also feel sorry for people who've lost so much, but only up to a point. I feel as sorry for them as I do for borrowers who failed to read the disclosure and loan documents provided to them when they borrowed a subprime loan.  They have some responsibility for their own unwise decisions. They may all be "victims," but I suspect that many are not victims who bear absolutely no fault for their current predicament.

What keeps me awake at night are possible claims by subprime borrowers against the purchasers of these worthless notes that allege that by their negligence in purchasing the notes, they enabled ABFS to stay alive and continue its victimization of more subprime borrowers who borrowed money on terms they thought too good be true.

Speaking of suckers related to the residential real estate market, the following is a faux ad that is as bitter as it is sweet (h/t American Digest).