The collapse of the subprime lending market has shaken borrowers and lenders as well as every key U.S. financial institution. As homeowners and financial markets struggle with the crisis, many businesses and investors - even those far removed from the mortgage industry - have also been forced to deal with the consequences. Carrington Coleman is helping a broad range of clients understand their exposure to the subprime fallout and credit market turmoil. __________________________________________________________________________________

Subprime Crisis Overview

The subprime mortgage crisis has been variously described as a meltdown, an octopus, a virus, an earthquake, a tsunami, and even a crime which has left Wall Street with blood on its hand.1 The metaphors are overblown, but failed subprime mortgage loans have caused, and will in all probability continue to cause, major disruption in international financial markets. Some analysts estimate that the net losses caused by subprime loans will eventually reach $500 billion, and that all credit-crisis related losses could eventually total $1 trillion.2

The subprime lending market is a relatively recent phenomenon. Between 1995 and 2003, the dollar value of subprime loan originations in the United States grew from $65 billion to $332 billion, an increase fueled in part by the demand for mortgage-backed securities (MBSs).3 A simple MBS pools similar loans, the income stream from which is sold to investors. Although MBSs were first issued by government sponsored enterprises (GSEs) such as Fannie Mae and Freddie Mac, GSEs are limited in the size and quality of loans they can purchase and securitize. Wall Street stepped in to meet demand by securitizing high risk, subprime loans, which accounted for approximately 25 percent of the $1.9 trillion of MBSs issued in 2006.4

In order to market these securities, issuers often created collateralized debt obligations (CDOs) and other structured investment vehicles. These products featured different slices, or “tranches,” of the income stream, with varying amounts of risk depending, in substantial part, on the order in which each tranche was paid. Senior tranches received high ratings because they were paid first and, as a result, were less risky than junior tranches. Thus packaged, subprime loans were sold to investors around the world, such as pension funds, municipalities, and insurers, many of whom were restricted by their charters to investing only in highly-rated debt.

The market for subprime loans collapsed in 2007 when the housing market slowed at the same time as rates on many subprime loans reset. Homeowners, who in a rising market would have been able to refinance or sell, were often forced to default on their loans. Markets for subprime CDOs disappeared as the investments lost value, and investors who faced margin calls were unable to unload subprime-backed assets. By January 2008, banks had announced more than $135 billion of subprime-related write-downs and losses.5

As financial markets continue to come to terms with the scope of subprime losses, market participants have headed to courthouses to shift their losses. The result has been a wave of litigation, with evolving theories of recovery and liability. As the crisis has deepened, regulators and legislators have begun to struggle with how best to address the current financial disruptions and prevent their recurrence.

Recent developments in subprime litigation and regulatory investigations, as well as legislative and regulatory initiatives to address the crisis, are discussed in more detail in the articles below.

Footnotes

1. See Randall Dodd, International Monetary Fund, Subprime: Tentacles of a Crisis, Finance & Development (Dec. 2007); Subprime Mortgage Crisis: Future Uncertain, http://www.foreclosurelistings.com/blog/general/subprime-mortgage-crisis-future-uncertain.htm; Posting to Herb Greenberg’s MarketBlog, Should Wall Street Turn Over Bonuses to Subprime Victims?(Nov. 28, 2007), http://blogs.marketwatch.com/greenberg/2007/11/should-wall-street-give-bonuses-to-subprime-victims/; Posting to The Agonist Blog, Sub-prime Market Earthquake Is Felt Worldwide, http://agonist.org/numerian/20070801/sub_prime_market_earthquake_is_felt_worldwide. 2. Charles R. Morris, The Trillion Dollar Meltdown, xii-xiii (2008). 3. Souphala Chomsisengphet and Anthony Pennington-Cross, The Evolution of the Subprime Mortgage Market, 88(1) Federal Reserve Bank of St. Louis Review 31, 37 (Jan/Feb 2006). 4. Faten Sabry and Thomas Schopflocher, NERA Economic Consulting, The Subprime Meltdown: A Primer, NERA Insights, Subprime Lending Series, Part I (June 21, 2007). 5. Julia Werdigier, Trading scandal diverts attention from Societe Generale’s subprime losses, International Herald Tribune, Jan. 29, 2008, available at http://www.iht.com/articles/2008/01/29/business/loss.php; see also Sabry and Schopflocher,
supra note 4. __________________________________________________________________________________

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