Miami Sues The Banks: Unlimited Liability Could Cause A New Crisis

|
Includes: BXUB, BXUC, CAPX, DHVW, EPS, FTA, IVE, IVV, IVW, IYF, LLSP, RPG, RPV, RSP, RWL, RYARX, SDS, SFLA, SH, SPDN, SPLX, SPUU, SPVU, SPXE, SPXL, SPXN, SPXS, SPXT, SPXU, SPXV, SPY, SPYG, SPYV, SSO, TALL, UPRO, VFINX, VOO, VOOG, VOOV
by: Jesse Moore

Summary

The Supreme Court has heard oral arguments for a case brought by the city of Miami vs. the big banks.

This lawsuit opens up the possibility of unlimited liability to banks that could result in the next financial crisis.

In the past, policies that have attempted to prevent discrimination have resulted in the opposite as companies find alternative methods of evaluating risk.

Governments should think hard about solutions, rather than fire off a lawsuit that would severely damage the economy.

On November 8th, the Supreme Court heard arguments for the city of Miami to sue the banks whose admittedly near-criminal lending practices led to the great recession. It's not hard to imagine why. Lost tax revenue, damage to the economy (NYSEARCA:SPY), and a displaced populace.

Unlimited Liability

Underneath the skin of the lawsuit is something dangerous. If this trial goes ahead, it opens up the prospect of unlimited liability. Everyone in American society would be worse off as companies came to grip with the idea. Forbes columnist, Daniel Fisher, describes the dangerous suit as follows:

"...why can't Miami sue for lost tourist revenue? Sales taxes? Why can't the corner store sue the banks for the money its customers stopped spending when they lost their homes? Where does the chain of causation end?"

It is hard to draw a line where the liability stops. If this case is allowed to proceed, a torrent of cases could be brought forward. Banks, scared of unlimited liability would immediately scale back lending practices.

Discriminatory Lending

Miami's case hinges on statistical evidence that the banks explicitly discriminated against racial minorities. I doubt many of us are surprised that this occurred, and I don't doubt that the lawyers for the city of Miami can prove it. However, these practices are better dealt with by legislation, despite the difficulties that lie in pursuing that route.

People, and companies as an extension of people, are affected by past experiences. That is why it is so important to understand the effect that these events have on business practices. A perfect example is the "ban-the-box policy." A policy that banned companies from asking prospective employees whether they had a criminal history. It sounds great in theory - try to prevent employers from discriminating against convicted felons.

In practice, as is usually the case, it's not that simple. Instead of convicted felons receiving less discrimination, their discrimination grew to target all members of high-risk racial groups. African Americans and Latinos are far more likely to have a previous jail stint. Thus, companies simply moved to exclude all, or most, candidates from ethnic minorities in their hiring process.

"...black and Hispanic men without college degrees are significantly less likely to be employed after 'ban the box' than before." Collateral Consequences Resource Centre

The obvious effect of these lawsuits could be a shutting out of the poor from the housing market, or lending in general. An increase in loan sharking, sickening pay-day loans, and even further distress for the poor that the city of Miami was supposedly standing up for.

Economic Consequences

At a larger scale, the national and global consequences could be tremendous. Where is the ceiling of liability in this case? You then have to contend with an innumerous number of lawsuits afterward. The banking system could quickly reach gridlock. Unfortunately, now that this case is receiving quite a bit of publicity, even a settlement could be disastrous.

Miami's case could be one of the most important cases since the GFC. It opens up a prospect that would terrify banks and companies that operate in the U.S. If lending suddenly collapses as risk models are adjusted, and banks become infinitely liable for any adverse outcomes as a result of their lending practices, the next financial crisis would be upon us.

To be sure, banks policies were horrendous in the lead up to financial crisis. That being said, society needs to finds a way of punishing them that does not further damage itself. It does not make sense to wage an all out war that defeats your opponent, and yourself in the process. Governments, whether they are a city, state, or national government, should not pursue strategies of momentary gain instead of long term stability. These problems require careful thought and careful implementation. Lobbing a grenade into a society that is still recovering from the effects of the last crisis is a poor solution to a difficult problem.

Investors can add this to a long line of concerns to watch as the S&P sticks near all-time highs.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.