Lehman was big, early supporter of subprime

Lehman Bros. was an early and enthusiastic backer of subprime lending. It purchased the mortgages and used pools of the loans to back complex bonds, many of which were sold overseas. Merrill Lynch came onto the scene later.

After the late-1990s meltdown in the subprime securitization business, Lehman stepped in with funds and other services that enabled First Alliance of Irvine to continue business in 1999 and 2000 despite lawsuits filed by state attorneys general, consumer groups and AARP.

A 2003 decision by a Santa Ana federal jury, later upheld on appeal, found Lehman liable for aiding and abetting a carefully scripted First Alliance fraud targeting elderly and financially strapped homeowners. Plaintiffs’ attorneys had focused on internal memos, especially a Lehman due-diligence report that said First Alliance required its employees “to leave your ethics at the door.”

Lehman pressed ahead in the business, saying it believed that it was a positive influence on the practices of the lenders it backed. Later, Lehman became the first in a host of Wall Street banks to operate subprime originators and loan-servicing companies.

Merrill, by contrast was among the last to get into this “vertical ownership structure,” said Bill Dallas, who started one subprime lender that wound up at Merrill, First Franklin of San Jose, and had started another, Ownit Mortgage Solutions of Agoura Hills, in which Merrill bought a 20% stake.

“Merrill was late, late, late” and trying to catch up with Lehman when it bought First Franklin and the Ownit stake, Dallas said.

Ownit was among the first of the subprime lenders to collapse, filing for bankruptcy in late 2006, and Merrill was later forced to shut down First Franklin as its losses mounted.

Such scenarios industrywide have led Wall Street banking firms to write down their mortgage-related holdings by more than $500 million.

-- E. Scott Reckard