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Morgan Stanley settles for $3.2 billion over 'deceptive' mortgage bond practices

Internal e-mail: We are running under the radar and do not want to document this

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Morgan Stanley will hand out hundreds of millions of dollars in consumer relief and fork over hundreds of millions more to state governments as part of $3.2 billion settlement over its “deceptive” mortgage bond practices in the run-up to the financial crisis, the New York Attorney General’s Office said Thursday.

According to a release from New York Attorney General Eric Schniederman, Morgan Stanely will provide $400 million in consumer relief for New York residents and pay $150 million to the state of New York as part of the massive settlement.

The settlement stems from Morgan Stanley’s alleged misrepresentations about the security and safety of residential mortgage-backed securities it sold before the financial crisis.

According to Schniederman’s office, Morgan Stanley made multiple representations to RMBS investors about the quality of the mortgage loans it securitized and sold to investors, and its process for screening out questionable loans.

“Contrary to those representations, Morgan Stanley securitized and sold RMBS with underlying mortgage loans that it knew had material defects,” Schniederman’s office said in a release.

The settlement was negotiated through the Residential Mortgage-Backed Securities Working Group, a joint state and federal working group formed in 2012 to share resources and continue investigating wrongdoing in the mortgage-backed securities market prior to the financial crisis.

Rumors about this settlement began to trickle out last year, when Morgan Stanley reportedly was in talks with Schneiderman’s office about its pre-crisis practices.

Morgan Stanley also disclosed in an filing with the Securities and Exchange Commission last year, that it was expecting to be the subject of a lawsuit filed by Schneiderman over approximately 30 subprime securitizations sponsored by the company.

In the agreed-upon statement of facts, Morgan Stanley acknowledged that it increased the “acceptable risk” for the underlying loans in the mortgage pools.

That increase allowed Morgan Stanley to purchase loans that had loan-to-value ratios of more than 100%, but did not disclose that information to the bond investors.

According to Schniederman’s office, Morgan Stanley staff acknowledged this fact in several e-mails.

The statement of facts showed that in a May 31, 2006 email, the head of Morgan Stanley’s due diligence team that was tasked with reviewing the value of the properties supporting the mortgage loans asked a colleague, “please do not mention the ‘slightly higher risk tolerance’ in these communications. We are running under the radar and do not want to document these types of things.”

The statement of facts also showed that in another emails, from Nov. 21, 2006, another member of Morgan Stanley’s due diligence team forwarded a list of questionable loans for review and approval to purchase them, stating “I assume you will want to do your ‘magic’ on this one?”

In another similar instance from July 2006, the head of Morgan Stanley’s valuation due diligence team cleared dozens of risky loans for purchase after less than one minute of review per loan file, Schniederman’s office said.

As part of the settlement, Morgan Stanley also acknowledged that it securitized certain loans that neither complied with underwriting guidelines nor had adequate compensating factors.

Schneiderman’s office also said that after its finance team decided that the loans had “acceptable risk,” Morgan Stanley purchased and securitized many loans that its credit and compliance team recommended not be purchase.

Morgan Stanley also allowed loans that it knew were risky to be purchased and securitized without a loan file review for credit and compliance, Schneiderman’s office said.

The resolution requires Morgan Stanley to provide significant community-level relief to New Yorkers, including loan reductions to help residents avoid foreclosure, and funds to spur the construction of more affordable housing, Schneiderman’s office said.

Additional resources will be dedicated to helping communities transform their code enforcement systems, invest in land banks, and purchase distressed properties to “keep them out of the hands of predatory investors,” Schneiderman’s office also said.

"Today’s agreement is another victory in our efforts to help New Yorkers rebuild in the wake of the financial devastation caused by major banks,” Schneiderman said. "Today’s settlement will deliver resources to the families and communities that need them the most, while helping New Yorkers avoid foreclosure, and spurring the construction of more affordable housing units statewide."

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