Subprime Litigation Threat Hangs over Industry

An economic consulting firm says that the subprime credit crisis is behind an increase in class action lawsuits during the first half of this year. And that boomlet may just be the beginning of a subprime bonanza for plaintiff attorneys.

NERA Economic Consulting, New York, says shareholder class action suits are on a pace to total 280 this year, which would represent a 42% increase over the 2007 level. And it means that filings of shareholder lawsuits will have doubled in just two years.

NERA says that 51% of the 2008 class action shareholder filings involve allegations related to the subprime mortgage collapse. However, NERA includes the auction rate securities cases in that number. But "market volatility" is also a factor behind shareholder lawsuits. With stocks bouncing around quite a bit and the overall market down over the past year, attorneys are scrutinizing company filings looking for excuses to sue. And anyone who's in the executive suite of a mortgage company or, perhaps, a government-sponsored enterprise can tell you that swooning stock prices create a hornets nest of disgruntled investors.

The probability of a company facing a class action lawsuit over a three month period following a one day drop in its stock price increases with the size of that stock price drop, NERA notes somewhat dryly but not at all surprisingly. Nearly one-third of firms whose stock price fell by 40% or more in a single day were confronted with a lawsuit within three months.

On the positive side, while filings are up, NERA says that the average settlement has remained roughly constant this year, at $30 million. Of course, bigger companies (that's you, Fannie Mae and Freddie Mac) face the potential for much larger than average payouts. But so far in 2008, only 2% settlements were for more than $100 million. In 2006, NERA says the figure was closer to 10%.