Throughout the financial crisis and subsequent bailout of the U.S. banking system, the issue has been one of Wall Street versus Main Street. That is, the idea that greedy bankers, investment bankers, and Wall Street traders duped unsophisticated Americans into mortgages that they could not afford and then left them hanging when things went bad.
Whether that versions of events is true or not is open to debate. However, what has been missing so far from the banking crisis scenario is that numerous investors, very sophisticated, institutional investors, were also "duped" by Wall Street titans and those too-big to fail banks. Those investors were buying AAA-rated bonds from reputable investment firms and banks. They were not buying risky, high-yield bond investments, or so they thought.
An article over at MSNBC underlines those circumstances and suggests that the next phase of the mortgage crisis debacle may just now be getting underway, thanks in part to the complexities and speed of the U.S. legal system.
Banks Sued Over Mortgages Used For Bonds
Giants of the bond market’s investing world such as PIMCO Investment Management, and Blackrock Financial Management, two of the biggest fixed-income mutual fund managers in the world, as well as Charles Schwab, and others, have begun suing banks like Citigroup over investments they bought during the run up to the real estate market crashing and triggering the so-called Great Recession.
These investors are suing on several grounds, but their argument centers around the concept that the investments they bought, did not match the investments they were sold. The documents attached to the bonds that were purchases promised certain things like underwriting standards that would be followed. The investors are claiming that those standards were not met, and that the companies selling the investments were aware of it.
The difference between the fight between the banking giants and people stuck in "bad" mortgages is two-fold. First, there is some blame for those who got into mortgages that are now problematic. Whether they fully understood what they were getting into, or if they never got all the facts, they did seek out, and obtain the mortgage, and helped along the process of getting approved. Second, the power of individual homeowners against financial titans is limited.
But, the investors who got stuck holding the bag when they bought what they were supposed to be buying, low-risk, highly-rated, fully underwritten, mortgage backed bonds, don’t have the same liability. The only argument the banks have is that all investments have some risk and that is not their fault. That only holds water if the risk they warranted in the documents that created the bonds was factual. More importantly, these big-name investors are equally matched with the banking titans they are aiming at, with just as much time, money, and resources to dedicate to attorneys, lawsuits, and court costs.
Bank Stocks Outlook
What does this all mean for investments in banking stocks and other financials in 2011?
That depends on how these cases unfold. If they get past the initial stages — a good bet — then companies will have to start setting aside or reporting large amounts of money as possible losses if they end up losing what are sure to be giant lawsuits. If things go well for the plaintiffs in the first wave, expect a bigger bolder, second wave to show up in mid to late 2011.
In other words, the outlook for the financial sector in 2011 might be worse than it seems as the end of 2010 approaches. Stay on your toes and be ready to shed banking investments if things take an unfavorable turn in the courtroom.