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Cleveland Can't Sue Banks that Financed Subprime Loans

As the crumbling of the American subprime housing market triggered economic crisis across the nation and world, Rust Belt cities like Cleveland were particularly hard-hit.

By 2007, the Cleveland metropolitan area had the seventh-highest rate of foreclosures in the nation, the Columbus Dispatch reported. One of every 57 homes was in foreclosure.

The empty homes became eyesores and fire hazards, attracting squatters, looters and drug dealers. In 2006, Cleveland's violent crime rate rose by 11 percent, compared to a 1 percent rise nationally, the Cleveland Plain Dealer reported in 2007.

As the nation's economic cold became pneumonia in Cleveland, the city looked to recover the millions lost from tax revenues and the millions spent on the problems abandoned homes caused. The city looked to punish the wrongdoer. It looked to Wall Street.

Cleveland Rocked

In January 2008, the city filed a public nuisance lawsuit against more than 20 banks and mortgage companies in Cuyahoga County Common Pleas Court, saying the companies were at fault for the blight sweeping Cleveland. These were the companies that financed mortgage lenders, then bundled the lenders' subprime loans as mortgage-backed securities, essentially creating the subprime craze, the city contended in City of Cleveland v. Ameriquest Mortgage Securities, et al.

"Our point was what was driving the market beginning in 2003 was Wall Street going out looking for subprime mortgages to back these mortgage-backed securities rather than lenders going out looking for these people," says Cohen, Rosenthal & Kramer Partner Joshua Cohen, who argued the case for Cleveland.

A U.S. district judge threw out the suit in May 2009. The city appealed, but in late July the case was dealt another crushing blow. When the 6th Circuit rejected its arguments that the case should be heard.

It's a case that has garnered much media attention, including a documentary that debuted at the Cannes film festival in 2010. Similar suits are ongoing from Memphis and Baltimore, cities also ravaged by the burst of the subprime bubble (see "Reverse Redlining").

While the news sites ran "Cleveland vs. Wall Street" headlines (also the title of the documentary), the 6th Circuit didn't see the dramatic David and Goliath story the media did. Instead, the three-judge panel rejected the case based on what it didn't see--namely, a direct tie between the actions of the 22 financial institutions named in the suit and the economic decay in Cleveland.

Directness Not Met

The court found the companies, including Bear Stearns, Goldman Sachs and Wells Fargo, were financing a market for subprime loans rather than making the loans directly to Cleveland homeowners, so the proximate cause standards set in a 1992 Supreme Court decision, Holmes v. Sec. Investor Prot. Corp., were not met.

In the Cleveland case, Judge Fred Suhrheinrich wrote that the Ohio Supreme Court used the Holmes standard in a 2002 case in which Cincinnati tried to sue several gun companies.

"Holmes is the seminal United States Supreme Court decision that discusses the directness requirement, and the Ohio Supreme Court has adopted the Holmes Court's proximate cause analysis," Suhrheinrich wrote.

Cleveland disagrees and, in August, filed an appeal for an en banc rehearing.

"In our view the panel had applied federal standards to resolve what we thought was a state issue," Cohen says.

Cohen adds that Ohio case law has different standards for proximate cause, including that there can be more than one cause and, citing a 1957 Ohio Supreme Court ruling about a particularly complicated auto accident, that proximate cause exists if the injury wouldn't have taken place without a chain of events stemming from an initial misdeed.

But Jones Day partner David F. Adler, who argued the case for the appellees, says the decision "adds to a growing body of case law" affirming that directness--not just forseeability--is required in determining proximate cause. This will have effects far beyond subprime mortgage cases, he says.

"What defense lawyers are going to have, not only in the 6th Circuit but across the country, is the ability to point to a very respected court of appeals ruling that directness is part of proximate cause," Adler says. "A lot of practitioners don't appreciate that proximate cause has two elements: directness and forseeability."

Placing Blame

In its appeal, Cleveland says the fault came when the financial institutions created a bubble that would burst.

"These parties either knew or should have known that a tidal wave of foreclosures would result from the new mortgages they were financing in the City, bringing with it all of the attendant injury and damage," the en banc appeal reads.

Suhrheinrich addressed the city's allegation of foreknowledge in his opinion, calling it "not relevant." But Greg Taylor. litigation counsel at the American Bankers Association Litigation Counsel, sees the case as pushing the blame past people who took on loans they couldn't pay back.

"At some point, the people who were getting the loans, the homebuyers, are responsible for the upkeep of the property," says Taylor, who heads the ABA's amicus program.

As for the lenders who made loans to people who couldn't pay them back, the city can't sue them. As the district court stated when it threw out the case in 2009, the Ohio Revenue Code forbids municipalities from regulating mortgage companies.

Contributing Author

Paul Dailing

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