EclectEcon

There have been more than 7000 foreclosures during the past two years in Cleveland. Consequently, the Mayor is suing financial institutions for "at least $100m", blaming the lenders for the financial problems of the borrowers and, as a result, the entire city [source: NYTimes].

Cleveland is suing 21 of the nation’s largest banks and financial institutions, accusing them of knowingly plunging the city into a financial crisis by flooding the local housing market with subprime mortgage loans to people who could never repay.

The city is seeking “at least” hundreds of millions of dollars in damages, Cleveland’s law director, Robert J. Triozzi, said Friday. The list of defendants includes some of the most prominent firms on Wall Street, like Citigroup, Bank of America, Wells Fargo, Merrill Lynch and Countrywide Financial.

Mayor Frank G. Jackson said in an interview on Friday that the companies would be “held accountable for what they’ve done.”

“We’re going after them to get the resources we need to rebuild our city,” Mr. Jackson said.

The financial crisis has hit Cleveland especially hard, with more than 7,000 foreclosures in each of the last two years, Mr. Jackson said. Entire city blocks have been abandoned. The city’s budget has been strained by the effort to maintain thousands of boarded-up homes, and by the cost of responding to a rise in violent crime and arson.

... The Cleveland suit, filed Thursday in Cuyahoga County Common Pleas Court under the state’s public nuisance law, asserts that the financial institutions created nuisances across broad swaths of Cleveland because their loans led to widespread abandonment of homes. “We’ve torn down 1,000 abandoned houses, and haven’t even made a dent,” Mr. Jackson said.

The drop in homeownership, and a steep decline in population — to 444,000 residents in 2007 from almost a million in 1950, according to census figures — has drained Cleveland’s budget. In December, Mr. Jackson announced that the city was unable to borrow money and would be forced to postpone or permanently shelve millions of dollars in public works projects.

“The strain on our budget is too much,” Mr. Jackson said. “These companies have knowingly created a public nuisance by exploiting the city of Cleveland.”

Before proceeding with the suit, however, the city of Cleveland might want to worry about whether they will be hit with massive legal fees for having filed a nuisance suit:

• Why are the homes being abandoned? Why are there no buyers, even at repo or distress prices? It is really hard to blame the lenders for the lack of demand for housing.
• The city of Cleveland might want to look into what proportion of the defaults was due to borrower, not lender, fraud. Arnold Kling has been suggesting this possibility for at least a month.

And Tyler Cowen summarizes this view very nicely,

There has been plenty of talk about “predatory lending,” but “predatory borrowing” may have been the bigger problem. As much as 70 percent of recent early payment defaults had fraudulent misrepresentations on their original loan applications, according to one recent study. The research was done by BasePoint Analytics, which helps banks and lenders identify fraudulent transactions; the study looked at more than three million loans from 1997 to 2006, with a majority from 2005 to 2006. Applications with misrepresentations were also five times as likely to go into default.

Many of the frauds were simple rather than ingenious. In some cases, borrowers who were asked to state their incomes just lied, sometimes reporting five times actual income; other borrowers falsified income documents by using computers. Too often, mortgage originators and middlemen looked the other way rather than slowing down the process or insisting on adequate documentation of income and assets. As long as housing prices kept rising, it didn’t seem to matter.

In other words, many of the people now losing their homes committed fraud. And when a mortgage goes into default in its first year, the chance is high that there was fraud in the initial application, especially because unemployment in general has been low during the last two years.