Looming Sets of Defaults and Foreclosures

Speakers at the recent Subprime Summit in New York, hosted by the banking and financial advisory firm of Duff & Phelps, said one area of concern going forward is the FHA program. It has licensed a number of failed mortgage brokers, they said.

Since September, the industry has seen $400 million of new subprime debt issued through FHA guarantees, according to panelist William O'Connor, a partner with Crowell & Moring LLP, in its financial services practice.

"The program is set up to help people with moderate means. Supposedly, the loan payments are not more than 30% of their income. But they are very loose-leaning standards. People should be worried about the fact it's going on. We're still out there generating subprime paper even if it's not through securitization." The securitization market no longer exists, and FHA has become a substitute for subprime mortgages. During the next two months, things are going to get worse, the speakers agreed. Defaults will continue to rise across the board as unemployment goes up.

The foreclosure crisis is out of control and it has snowballed into an economic crisis. What has happened in the mortgage market has had a ripple effect on the world economy, and the subprime meltdown is at the core of everything that has happened in the credit markets.

The speakers said they expect to see increased "creative" litigation to present itself in the near future. The ratings agencies will be shaken by class-action lawsuits. There will be possible legal action against loan administrators. Was there a corrupt underwriting process? How good was the disclosure?

Mr. O'Connor said he anticipates there will be a surge in TILA litigation being brought by borrowers. Servicers will likely be sued for negligence in the administering of the loan.

The commercial side of the market will also be affected by the economy. Office buildings and strip malls across the country are seeing increased vacancies, which is putting more stress on bankruptcies. Commercial properties are picking up in mortgage default and real estate-owned assets.

The Troubled Assets Relief Program is supposed to hold over $350 billion for the next administration. While it made sense for the federal government to purchase and hold troubled assets, Treasury ran into multiple issues in this monumental task. So now, there is uncertainty over who will get the funds. It will only be used to purchase good mortgages and not troubled assets. There is no safety net for MBS toxic assets.

Going forward at a new regulatory regime, Lance Cassak, special counsel, litigation practice, Baker Botts LLP, said the first question is going to be who is going to get regulated?

"We are looking at the prospect of the bailout for everybody. How far are we going to reach? Are we going to leave any unregulated pockets?"

Mr. Cassak said he sees 2009 a lot like 1989. "1989 was the year a new administration was created. It was a really an effort by the new administration, a bipartisan consensus, that the mortgage crisis was a smaller problem, comparatively, for a new regulatory framework," he said.

"I think 2009, what I'm hearing, is maybe we need a whole new restructuring of our regulatory structure. We have a lot of different players here - the FCC, to a lesser extent the banking agencies. The second question is whose model will be used? In my experience with the FCC, they have been primarily concerned with the process and not so much with results. Its primary focus is ensuring everyone has access to same accurate info. The Office of Thrift Supervision is much more comprehensive and much more result oriented."