Homeowners aim at Wall St to combat woes

NEW YORK (Reuters) - Wall Street and a growing army of lawyers are girding for more homeowners like Rodney and Sylvia Gibbons, as the real life consequences of the subprime mortgage crisis become evident in America.

The Gibbons, among eight New Yorkers fighting to keep their homes through the U.S. legal system, live on the first floor of a three-story rowhouse on Halsey Street in Brooklyn.

Boarded up buildings offer the first signs of impact of the subprime mortgage meltdown on the neighborhood, but other signs came earlier.

There was Rodney Gibbons' heart attack in 2002, when he and his wife Sylvia first tried to close on the house. Later came death threats to Sylvia from a tenant who wasn't paying her rent. Just down the street, another sign, in red block letters: "We Buy Homes."

The homeowners are suing Credit Suisse Group (CSGN.VX) and J.P. Morgan Chase & Co. (JPM.N), as well as sellers, lenders, appraisers, and other parties involved in the sale of homes financed with subprime mortgages that are often made to people with inadequate credit histories.

"The role of the investment banks in this process cannot be overstated," said Richard Neiman, New York's acting banking superintendent. "They are facilitators and earned fees at multiple stages in the process."

But Alan Vinegrad, a partner at law firm Covington & Burling, who is representing United Homes, the developer that sold properties to the Gibbons, said: "The lawsuits are without merit and we've moved to dismiss them in court."

Representatives at Credit Suisse and J.P. Morgan declined to comment.

ACCOUNTABILITY BLURRED

At issue is what economists call "moral hazard". If lenders receive a fee to originate mortgages, they may care more about quantity than the quality of the loans. And if lenders know they will be able to sell or securitize loans to investors, they may not worry about whether borrowers can pay their mortgages.

When home loans are securitized, they are often bundled together in packages known as collateralized debt obligations (CDOs) and sold to investors such as hedge funds.

Loans with varying degrees of creditworthiness are bundled into CDOs to diversify the risk for investors, but the lenders themselves, or managers of CDOs to whom lenders sold risky loans, may ultimately be the biggest losers, said Steve Kolyer, a partner at law firm Clifford Chance, which represents asset managers.

"To lump it all together and say there was predatory lending on all of Wall Street and securitization is the culprit is kind of silly," Kolyer said.

"The non-paying homeowner may be a victim of predatory lending practices, but that's a question mark. Is he a victim or part of the problem?"

"A lot of CDO investors view themselves as postured against loan originators," Kolyer said. "From the street perspective, it's the lenders themselves whose practices have to be looked at again."

Assigning liability is difficult because the very process of pooling debt and reselling it blurs the lines of responsibility for who actually owns the loans.

"One of the big problems with securitization is it splits the process into so many pieces," said Alan White, a lawyer with Community Legal Services in Philadelphia. "Accountability gets lost."

And defenders of the securitization process say financial innovation and low interest rates led to a record 69 percent home ownership rate recently, benefiting more than 73 million Americans.

Robert Houck, a partner in Clifford Chance's securities litigation group, sees homeowners' attempts to blame financial institutions for subprime lending practices actually starting legal fights among the lenders and investors.

"The ultimate litigation question is what about these people who are at the end of the food chain, who ultimately hold these big buckets of securities," Houck said. "Let's imagine that one of these end-of-the-road guys wants to sue."

The Gibbons claim against Credit Suisse is based on secondary liability, meaning the bank helped the other defendants by providing a secondary market for the lender to sell its risky mortgage loans, according to court documents.

Credit Suisse also assured the mortgage company Olympia Mortgage Co. that its affiliate DLJ would buy mortgage loans even if Olympia did not provide adequate information about the borrowers' income or ability to pay, the lawsuit claims.

LAWSUITS A LONG SHOT

By October 2002, Rodney, a custodian, and Sylvia Gibbons, a school bus monitor, were a few steps away from owning their first home after renting for more than two decades since moving to the United States from Barbados.

Mr. Gibbons, then 56, had a heart attack at the closing for the purchase of the house, according to court documents filed with the Eastern District of New York.

Then, a salesman repeatedly called to persuade the Gibbons to close the sale, promising a tenant who could rent a bedroom to help them pay the mortgage, according to court documents.

The Gibbons bought the house, and moved in with their son, his wife and their grandson. Later they had to find a tenant, who soon stopped making payments. The tenant threatened to burn the house down and kill Ms. Gibbons when she tried to evict her, according to the court documents.

Whether the plaintiff is a homeowner, investor or hedge fund, trying to tie liability for loans gone wrong to Wall Street banks is a long shot, legal experts say.

Sophisticated investors will have difficulty arguing they did not understand the risk, but borrowers like the Gibbons, may be daunted by the expense of the lawsuits and related research, said Sheila Canavan, a Berkeley, California-based consumer advocate lawyer who won a $75 million settlement about five years ago in a fraud lawsuit against First Alliance Mortgage.

"It's one of the toughest cases to bring," said Canavan, who represented more than 20,000 consumers in that case.

In a similar case, Lehman Brothers was found liable for aiding and abetting that fraud, and was found liable for $5.1 million, which still has not been paid.