The distressed mortgage investments that have triggered thecurrent subprime crisis have estimated losses approaching tens ofbillions of dollars.

These losses will clearly eclipse those caused by the implosionof Long Term Capital Management, a hedge fund that collapsed in thelate 1990s, and the entire liquidated loss of the Resolution TrustCorporation in connection with the Savings and Loan crisis in the1980s.

But unlike subprime's predecessor crises, figuring out who's toblame is not so easy.

Aggrieved investors will try to recoup their losses by lookingto third parties with deep pockets. Professional liability claimsmay be brought against the entire gambit of subprime mortgageplayers–auditors who gave mortgage lenders clean opinions shortlybefore imploding, directors and officers, attorneys, investmentadvisors, hedge fund and pension fund managers, and many others whoplaintiffs will claim have played some role.

Therefore, as with any professional risk, insurers mustunderstand their client's business, and where it fits into thescheme of losses. Keen underwriters should take a basic approach:understand what functions are performed by whom and how closecausally and legally they are to the injured parties.

It's no different than assigning blame in a product liabilitycase over a car crash. Every component maker might have liability,but the airbag supplier's and upholstery maker's faults are similarin kind only.

o The bottom-line: companies that are directly connected withmarketing, purchasing, pricing or insuring mortgage-backedsecurities are at the greatest risk.

o Secondary players with only indirect connection to residentialmortgages–like derivatives and credit insurance writers– fill thenext layer.

o Front-line professionals like real estate agents and mortgagebrokers, while still apt to become involved in the spat, are farenough removed from investor exposure to escape relativelyunscathed.

Some of the casualties of the subprime crisis are alreadyobvious. Public companies, such as Bear Stearns, Citigroup andothers, succumbed to massive write-downs of their mortgagesecurities portfolios. Their market capitalizations fell bybillions.

Investors (stockholders) have already filed scores of securitiescases asserting management failed to report the value of thesubprime assets held by the company in a timely manner. But theconverse is true as well–many financial institutions may treat thecurrent year as a “kitchen sink” year and be quick to write downassets. After all, how do you mark to market an illiquid asset?

Loan originators like NovaStar and New Century incurred massivelosses as investors demanded repurchase of underperforming loanportfolios and the investors and banks upon which they rely mademargin calls. This double whammy capital drain forced many out ofbusiness quickly.

These firms may face direct exposure to investors and from othercompanies who either relied on their advice, wrote credit swaps, orwith whom they had other financial dealings. They, in turn, oftenrelied on rating and underwriting agencies, accountants, andlawyers, and are also exposed to investor and company professionalliability claims.

What's more, fund managers have direct relationships with fundinvestors. Low global interest rates and yields caused investors toseek out returns, and many funds found them in the form ofmortgage-backed investments. Fund managers who bought riskymortgage instruments may face direct liability for their role inselecting the investments.

Lastly, real estate appraisers are a high-impact targetalthough, to date, they have been under the radar screen. Thisgroup has direct relationships with mortgage lenders to the extentthey offered independent valuations of real property that lendersused to justify mortgage programs. Lenders will point to accidentalor intentional inflation of home values as a causative factor whenthey underwrote underperforming loans.

Finance companies and investment banks that are not directlyexposed to residential mortgages could face exposures toshareholders and others.

Specialty finance companies still suffer badly if their businessmodel relies on short-term debt to fund their operations. Thesystematic margin calls caused a global unwinding of interconnectedleverage and has left these businesses scrambling for cash. Whilethese firms have no direct connection to souring mortgageinvestments, they and their stockholders are no doubt feeling thepinch.

Counterparties and insurers of mortgage lenders, while notdirectly exposed to angry investors, suffer when the big companysuffers. Excessive pressure in the credit derivative markets isalready bearing this out.

Not every firm connected with residential real estate and poorcredit borrowers faces catastrophic exposure to subprime mortgagelosses. Front-line professionals far removed from the aggrievedinvestors are in much better shape.

For example, mortgage brokers and real estate agents facerelatively little exposure to the subprime crisis because theirdirect relationships are with buyers and sellers.

By contrast with lenders and mortgage banks, mortgage brokersare arrangers of credit. They do not render investment advice norunderwrite buyer credit quality. These front-line professionalsfacilitate or arrange deals between willing buyers and sellers ofreal property.

Real estate and mortgage brokers do not face direct liabilityfrom the largest aggrieved class: the investors who ownmortgage-backed securities. These front-line professionals are muchsafer bets to survive the subprime crisis for at least threereasons:

(1) The legal nuance that all real property is unique.

Essentially, there is no material fact to misrepresent becausehome value is established by the convergence of a willing buyer andwilling seller. Real estate agents face borrower claims that theyoverpaid for their house, or did not understand the financing, butarrangers are not responsible for truth-in-lending disclosures.

(2) Difficulty in establishing damages.

An aggrieved investor will face a number of hurdles tracingliability back to a front-line professional. For example, manystates have remedy and anti-deficiency laws that require the ownersof most loans secured by real property to make a difficult choiceshould they not be getting paid.

The choice is to forego the security (the house) and sue theborrower on the note, or obtain the proceeds via exercise of apower of sale. In short, lenders can either get a money judgment orthe house, but not both.

The economy and security of foreclosure is far preferable toabandoning the security and obtaining an uncollectible judgment.What is usually left is a lender that bids the full value of theirnote at public sale. Successful or not, this “full credit bid” isan admission the property was worth at least the loan amount.Voil?–no damages.

(3) General unwillingness of mortgage lenders to bring directactions against real estate and mortgage brokers.

Most mortgages are still originated through independentchannels. Lenders are heavily dependent on the retail and wholesaledistribution channels and are therefore reluctant to alienate thesekey partners.

There is more bathwater than baby, but underwriters are wise tochoose risks carefully and favor risks further removed from thepricing, purchase, and security of mortgage-backed securities.

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