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Morgan Stanley Sued For Risky Mortgage Lending

Written By:
October 19, 2012 at 3:06 PM

Morgan Stanley

The American Civil Liberties (ACLU) filed litigation in U.S. District Court in New York. This lawsuit represents the first legal action that specifically names an institution that funded subprime loans as opposed to suing the bank that made the loans. The complaint alleges that Morgan Stanley collaborated with a division of the failed mortgage lender New Century Financial Corp to targeted African-Americans for the marketing of subprime mortgage loans.

According to court documents, the investment bank colluded with New Century Financial to sell mortgage products to blacks, which had unjustifiably high costs. These high-cost mortgage products also had a significant possibility of leading to homeowner default.

Then, Mortgage Stanley packaged these home loans into mortgage-backed securities (MBS), which it sold to bond investors. Morgan Stanley also received exorbitant fees by securitizing subprime mortgages and selling them on the bond market.

Seek Class Action Certification

The ACLU filed the complaint on the behalf of five Detroit, MI homeowners. The lawsuit reveals that Morgan Stanley played an active role that superseded the function traditionally played by investment banks. Between 2004 and 2007, Morgan Stanley significantly increased the volume of subprime home loans it funded.

Lenders make subprime loans to borrowers who have low credit scores. Borrowers must pay higher interest rates and fees compared to other mortgages. This makes subprime loans highly profitable for lenders.

The investment bank not only funded the mortgages but established volume targets and outlined the terms of the home mortgages.

The American Civil Liberties Union states that as many as 6,000 African-American homeowners in the Detroit metropolitan area may have been victims of lending discrimination by the institution. Therefore, the ACLU ask the court to certify the case as a class action because the investment bank targeted these borrowers with subprime mortgage products that it knew many borrowers could not afford.

Reverse Relining

One of the attorneys for the plaintiffs Elizabeth Cabraser describes Morgan Stanley’s actions as a type of “reverse redlining.” Redlining refers to the banking industry practice of refusing to make loans and provide other financial services in low-income areas.

Morgan Stanley built its subprime loan products specifically for “mass-marketing” to borrowers in low-income neighborhoods.

By “targeting communities of color,” the subprime loans increase the likelihood of borrowers defaulting on the loans and eventually facing foreclosure. “It violates the Fair Housing Act," said Cabraser.

Lending and Discrimination

The ACLU states that discriminatory practices in connection with the packaging of subprime mortgages constituted normal practice throughout the financial services sector and around the country.

“Recklessness” sums up one of the major complaints about the securitization of mortgages. Lenders have no concerns about approving risky borrowers, packaging the loans and selling them as mortgage-backed securities because they do not keep the transactions on their books.

Proponents of mortgage securitization support the practice because it allows lenders to move the assets from their books. This frees up resources and allows banks to make mortgages and other loans, which help fuel the economy.

Recently, Wells Fargo reached a discrimination settlement with the federal government for $175 million. In addition, Bank of America agreed to pay $335 million to settled charges of discriminatory lending practices.





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