A plan to offer some subprime borrowers a temporary break from higher interest rates could spark lawsuits. People who put up cash for the loans must weigh the cost of giving up higher interest rates against costs of defaults and foreclosures.
A temporary freeze on interest rates on some subprime mortgages may please homeowners and lenders, but the investors who bought securities backed by those mortgages soon may be on the phone to their lawyers.
"This is the kind of scheme that takes your breath away," said Richard Epstein, a University of Chicago law professor. "When people are losing breath, they run to their lawyers, not away from them."
"This is a real hammer," he said of the U.S. Treasury-led proposal that would have investors in mortgage-backed securities forgo billions of dollars in interest. "I think it's unconstitutional. It's confiscation of money."
A Minneapolis lawyer who has argued real estate cases before the U.S. Supreme Court, Jeff Eckland, said he foresees lawsuits on many fronts as a result of the plan -- both between private parties who feel forced to go along with mortgage forebearance and between investors and the government.
"If you can't trust a mortgage, what do you know you can trust in the real estate business?" said Eckland of Eckland & Blando.
In 2002, Eckland prevailed in a case where Congress unilaterally changed the terms of mortgages held by owners of low-income rural housing. The challenge led to a settlement that could reach $500 million.
Seth Leventhal, a partner at Dorsey & Whitney, thinks differently. Lenders and Treasury officials will try to close the path to litigation, he said.
"They have no interest in setting up a huge deal that would expose them to liability," he said.
That doesn't mean lawyers won't sue, anyway.
"You can't make anything lawyer-proof, given the creativity of lawyers," Leventhal said.
University of Minnesota law Prof. Prentiss Cox said getting everyone with a stake in mortgage investments to consent to what amounts to a mass workout of troubled loans will be a challenge.
"They can't even figure out who owns these things," Cox said. "There's a real problem getting anyone to agree to anything where ownership is opaque."
Grant Nelson, a law professor at Pepperdine University in Malibu, Calif., said some investors could have better standing for a lawsuit than others.
Many mortgages sold in pools are part of legal entities that give a trustee the right to make decisions on behalf of investors, he said. In Nelson's view, investors who agreed to be represented by a trustee could have little recourse to file individual suits.
But securities sold without such arrangements may leave individual investors free to take legal action.
"If they don't have that authority delegated [to a trustee], I'm assuming this is a very tricky legal question," Nelson said.
However, the realities of the housing market right now make the government plan as much a benefit to lenders and mortgage holders as it is to borrowers.
"We can paint this as great relief for homeowners," said George Karvel, real estate professor at the University of St. Thomas. "But I've got to tell you something, this is real relief for the lenders."
Homeowners on the hook for a total of $500 billion in subprime loans soon will face an end to their initial "teaser" rates of as low as 4 percent. In some cases, their monthly payments will jump 30 percent. That could lead to hundreds of thousands defaulting on loans, leaving lenders -- and investors in mortgage securities -- facing losses of 10 percent, 20 percent or more, Karvel said.
"The fact is the loss [resulting from extending those lower rates for five years] may not be particularly different than if you had substantial numbers of your pool properties go into foreclosure," Karvel said.
Mike Meyers • 612-673-1746