ACLU Sues Morgan Stanley, Targets Loan Securitizer Over Loan Originator

Posted on 17 October 2012

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By David Dayen

The ACLU plans to sue Morgan Stanley on behalf of five named plaintiffs (they will seek class action status), for the investment bank's role in fueling what they view as a discriminatory subprime bubble. In doing so, the ACLU will try to pioneer a new legal strategy, by going after the securitizer of the loans instead of the now-defunct originator.

In the lawsuit, expected to be filed on Monday, the A.C.L.U. claims that Morgan Stanley is culpable for predatory loans made through the New Century Financial Corporation because the investment bank lent billions of dollars to New Century, a now-defunct subprime lender, and pressured it to make troublesome loans to African-American borrowers who could not afford them.

Morgan Stanley packaged the loans made by New Century and sold them to pension funds and other large investors. But, the lawsuit claims, the bank went beyond the traditional role of an investment bank by requiring that the mortgage company churn out the wildly profitable loans that came with "dangerous" characteristics.

For example, the lawsuit says, many of the loans ultimately sold to investors were "stated income" loans, in which borrowers could estimate their incomes without having to provide supporting documentation.

Specifically, the ACLU accuses Morgan Stanley in this federal lawsuit of violating the Fair Housing Act and the Equal Credit Opportunity Act.

This opens a new front in the legal battle over mortgage and securitization fraud. In the past, investors and homeowners sued the company that sold the loans. This seeks to make culpable the investment firms that packaged the loans into securities. And that would expose a whole new set of actors to these discrimination claims. Given that the securitizers are mostly still alive, and the lenders mostly dead, this makes sense as a more profitable target. But it also rightly views the entire securitization machine as a harmonious unit. Morgan Stanley had to get more and more loans to feed demand for their mortgage backed securities product. They leaned on New Century Financial, as sure as every Wall Street bank leaned on a mortgage originator, to write more and more loans. And that's where the underwriting standards broke down. Ripping off minorities was a key part of this whole plan.

The Civil Rights Division of the Justice Department previously brought suit and settled with two major banks on housing discrimination claims. They settled with Wells Fargo for $175 million for steering minority customers into higher-rate subprime mortgages, though they qualified for prime rates. And they settled with Bank of America for $335 million over discrimination claims at Countrywide, the subprime lender BofA bought in 2008. But again, these were claims against the originator. The ACLU's suit ventures into new and promising territory. It's unclear what the ACLU is asking for, but let's just say a small-potatoes settlement is less likely.

New Century was perhaps the worst subprime lender. Their loans ended up in foreclosure at a greater rate than any other originator. They went bankrupt in March 2007. Morgan Stanley knew at the time that the loans were shoddy:

The A.C.L.U.'s complaint says, "Morgan Stanley actively encouraged lending tactics that increased the levels of risk associated with individual loans." […]

A former employee who testified in a separate civil suit against Morgan Stanley said that bank officials knowingly bought loans in which borrowers' debt levels were more than 50 percent of their total income, according to the A.C.L.U. lawsuit.

The bank, according to one former employee, typically did not require New Century to conduct a second appraisal of homes, fearing that the second look would result in a lower assessment and prevent the loans from being securitized, the suit says.

Securitizers across Wall Street are eyeing this lawsuit nervously.

David Dayen is a Santa Monica-based writer, speaker and political activist. He blogs at Firedoglake, where this article originally appeared.