Eric Schneiderman for Attorney General

Morgan Stanley to Pay $3.2 Billion Over Flawed Mortgage Bonds

May 18, 2016

As published in The New York Times on February 11, 2016.

Morgan Stanley will pay $3.2 billion to strike a settlement with state and federal authorities over the Wall Street firm’s creation of mortgage-backed bonds before the financial crisis.

Nearly a year ago, Morgan Stanley announced that it expected to pay $2.6 billion to federal authorities in the settlement. Since then, though, Morgan Stanley was pushed to offer more money. Much of the additional money will go to New York State.

The settlement, which was announced Thursday morning, is one of the last that is expected to come out of a working group that President Obama helped form in 2012 to deal with the flawed mortgaged-backed bonds that banks put together before the financial crisis. In the go-go years that preceded the crisis, Wall Street banks purchased subprime mortgages and packaged them into bonds that ended up suffering significant losses.

Morgan Stanley said on Thursday that it had set aside legal reserves to cover the agreement and would not take any additional charges in its coming financial results.

“We are pleased to have finalized these settlements involving legacy residential mortgage-backed securities matters,” a spokesman for the firm, Mark Lake, said in a statement.

Morgan Stanley relied on a few subprime mortgage originators, especially New Century, to feed its bond pipeline. In the settlement this week, Morgan Stanley agreed to a statement of fact that includes revealing details about its relationship with New Century.

Because Morgan Stanley did not originate mortgages itself, its settlement is much smaller than those struck by large consumer banks. Mike Segar/Reuters

The statement says that Morgan Stanley employees frequently tried to increase the “pull-through rate” of New Century loans getting into securities, even when the loans were lower quality than expected.

In thousands of cases, Morgan Stanley included loans that were worth more than the value of the underlying property – something it had told investors it would not do, according to the settlement.

Emails cited in the document suggest that Morgan Stanley employees knew that they were bending the rules to include riskier loans.

“Please do not mention the ‘slightly higher risk tolerance’ in these communications,” one employee said in an email quoted in the statement. “We are running under the radar and do not want to document these types of things.”

Morgan Stanley’s close ties to New Century were previously put on public display in a lawsuit filed against the bank by the American Civil Liberties Union.

The acting United States attorney in San Francisco, Brian J. Stretch, said on Thursday that “Morgan Stanley knew that in reality, many of the loans backing its securities were toxic. Abuses in the mortgage-backed securities industry such as these helped bring about the most devastating financial crisis in our lifetime. “

As part of the settlement, Morgan Stanley will pay $150 million in cash to New York State, and another $400 million in consumer relief, according to the office of the New York attorney general, Eric T. Schneiderman.

It is paying another $22.5 million to the State of Illinois.

Previously, Morgan Stanley agreed to pay $1.25 billion to the Federal Housing Finance Agency and $275 million to the Securities and Exchange Commission to settle investigations involving similar issues. In total, Morgan Stanley has paid about $5 billion to members of the residential mortgage-backed securities working group.

The agreement struck this week leaves Goldman Sachs as the last of the big Wall Street banks not to have completed its settlement with the federal working group. Goldman said last month that it expected its settlement to cost up to $5 billion.