Blawgletter recently listed the types of commercial litigation that we expected to come out of the still-embiggening subprime mortgage mess. We included:
Securities fraud. Buyers of stock or bonds whose price fell after disclosure of problem investments in subprime mortgages (either the mortgages themselves or loans to fund the mortgages), subprime mortgage firms (stock), or subprime mortgage bonds.
We didn’t have particular firms in mind, but now we do — and the collection includes banking behemoths Merrill Lynch and Citigroup. After reporting $5 billion and then $7.9 billion in losses last month, Merrill fired its CEO and now has drawn a securities class action lawsuit against it (courtesy of Chitwood Harley Harnes in Atlanta). The complaint alleges that Merrill hid its exposure to "collateralized debt obligations" involving subprime loans and that the worst news may not have come out yet.
The same story pretty much applies to Citigroup, which lately disclosed big hits on its CDO portfolio and whose CEO quit before the board could show him the door. According to the WSJ, the company will soon announce another $8 billion in losses on "mortgage-related securities." We haven’t seen any securities fraud cases yet, but they will come.
We don’t feel too sorry for Merrill, Citigroup, or the other big boys and girls who put too many eggs in the subprime basket. The subprime business looked great as long as you didn’t take any risk that the borrowers wouldn’t repay their loans. (A Wall Streeter who did subprime securitizations agreed with us last year. He underscored the point by making sure we knew that he worked for a "moving company" and not a "warehouse".) A Day of Reckoning looked inevitable. The question was — who’d be holding the bag when the Day arrived?
Looks like Wall Street got more than its fair share. Firms didn’t content themselves with billions in fees for packaging subprime loans into securities and selling the securitizations to investors. No. They also put their own money into the subprime debt.
Hubris — or greed? Take your pick.
Barry Barnett