June 28, 2010
Wall Street investment bank Morgan Stanley has agreed to pay $102 million to affected Massachusetts homeowners and the Commonwealth for its role in securitization and financing of Massachusetts subprime loans.
The settlement follows an investigation by Massachusetts Attorney General Martha Coakley.
More than 1000 Massachusetts homeowners will receive $58 million as part of the agreement. Another $23 million goes to the Massachusetts Pension Fund for investment losses, and $19.5 million goes to the Commonwealth's General Fund.
"This has become an all-too-familiar pattern in which the deceptive practices of Wall Street devastated homeowners and investors, and ultimately contributed to the collapse of our economy," Coakley said. "Our extensive investigation revealed that Morgan Stanley not only backed loans for homeowners that they should have known were destined to fail, they also caused additional damage in the subprime marketplace.
Through today's action, we have secured significant relief to help keep hundreds of people in their homes and also recovered nearly $20 million for Massachusetts taxpayers."As a result of a lengthy investigation, the attorney general's office alleged that Morgan entered the subprime arena in Massachusetts by offering funding to retail lenders that specialized in loans to less-qualified borrowers.
Morgan provided billions of dollars to subprime lender New Century, which used Morgan funds to target lower-income borrowers and lure them into loans that consumers predictably could not afford to pay. These loans often were unsustainable because of payment shock or poor underwriting, but were lucrative for subprime lenders, who generated fees and could expect that borrowers would have to refinance in the short term or face foreclosure. Some Morgan Stanley investment bankers referred to New Century as Morgan's "partner" in the subprime lending business.
Change business practices
In addition to the $102 million in financial compensation, the settlement requires Morgan to change its future business practices and to provide information and materials needed in the attorney general's continuing investigation of the subprime securitization marketplace.
Massachusetts has previously brought actions against Goldman Sachs, Fremont General, Countrywide, and State Street Bank, over their roles in subprime lending. As a result of these actions, these companies have paid more than $130 million in relief to investors and borrowers, ensured mortgage relief to more than 15,000 homeowners in the Bay State, and recovered more than $50 million in taxpayer funds returned back to the Commonwealth.
Allegations in the Assurance of Discontinuance, filed in Suffolk Superior Court, include that Morgan provided funding, known as "warehouse lending" services, to New Century, which New Century in turn used to fund an ever-increasing number of subprime loans.
After New Century made the loans, Morgan would place the loans into a securitization pool, and then act as the underwriter selling investments backed by the subprime loans in the pool.
Repeated violations
As part of this securitization process, Morgan employed third party due diligence providers to review the quality of New Century's loans. During this review, Morgan learned that New Century repeatedly violated the Massachusetts Division of Banks' "borrower best interest" standard when it made subprime loans, and thus made loans that violated Massachusetts law.
Coakley's investigation shows that in late 2005 and early 2006, Morgan began rejecting greater numbers of New Century loans as a result of the due diligence findings. After New Century suggested it would shift its business elsewhere, Morgan began again to include a wider range of New Century loans in its purchase pools.
A Morgan Stanley senior banker purchased loans that Morgan's own internal due diligence team initially rejected, and Morgan waived vendor concerns regarding a substantial number of the New Century loans identified as having material problems.
Moreover, as New Century finally spiraled towards bankruptcy -- its risky lending practices exposed to the public -- Morgan Stanley reportedly continued to lend money to the subprime originator even when other banks would no longer provide New Century with cash. During early March 2007, Morgan Stanley provided millions of dollars that New Century used directly to finance a last round of unsustainable predatory loans in Massachusetts.
Throughout 2006 and the first half 2007, Morgan continued to securitize New Century's predatory subprime loans, and sold investments to two Massachusetts state entities-the Massachusetts Pension Reserves Investment Trust (PRIT) and the Massachusetts Municipal Depository Trust (MMDT). This led to state funds being used to fuel predatory subprime lending, and to significant losses for PRIT and the MMDT.
