(CN) - Morgan Stanley will pay $3.2 billion to settle claims over its sale and issuance of mortgage-backed securities prior to the 2008 financial crisis, the Justice Department announced Thursday.
Under the terms of the agreement, Morgan Stanley will pay $150 million to New York State, and another $400 million in consumer relief.
Under the terms of the agreement, Morgan Stanley acknowledges that it failed to disclose critical information to prospective investors about the quality of the loans underlying its residential mortgage-backed securities.
According to the government, investors, including federally-insured financial institutions, suffered billions of dollars in losses due to actions Morgan Stanley took in 2006 and 2007.
A residential mortgage-backed security are an investment vehicle comprises of a pool of mortgage loans made by banks and other financial institutions. The performance of the security is determined by a number of factors, including the credit-worthiness of the borrowers and the value of the underlying properties.
As part of the settlement, Morgan Stanley agreed to a statement of facts that detailed its activities leading up to the financial crisis.
For instance, Morgan Stanley told investors that it did not securitize loans that exceeded the value of the underlying property. "However, Morgan Stanley did not disclose to investors that in April 2006 it had expanded its risk tolerance in evaluating loans in order to purchase and securitize everything possible, the statement said.
"As Morgan Stanley's manager of valuation due diligence told an employee in 2006, '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.'"
As a result, Morgan Stanley ignored information - including broker's price opinions, which are estimates of a property's value from an independent real estate broker - indicating that thousands of securitized loans were underwater, with combined-loan-to-value ratios over 100 percent.
In the settlement, Morgan Stanley acknowledged that it "securitized nearly 9,000 loans with BPO values resulting in [combined loan to value] ratios over 100 percent."
The company also now acknowledges that it did not tell investors that Morgan Stanley employees received information that, in certain instances, loans that did not comply with underwriting guidelines governing the securities marketed to investors.
Similarly, Morgan Stanley admitted that while it told potential investors that it had a rock-solid due diligence regime, "certain of" its "actual due diligence practices did not conform to the description of the process set forth" in those materials.
The bank has also acknowledged that "Morgan Stanley was aware of problematic lending practices of the subprime originators from which it purchased mortgage loans." However, it "did not increase its credit-and-compliance due diligence samples, in part, because it did not want to harm its relationship with its largest subprime originators."
In fact, the government says, Morgan Stanley's manager of credit-and-compliance due diligence was admonished to "stop fighting and begin recognizing the point that we need monthly volume from our biggest trading partners and that ... the client [an originator] does not have to sell to Morgan Stanley."
In conjunction with the federal settlement, Morgan Stanley also agreed to pay New York State $550 million and Illinois, $22.5 million, to settle lawsuits they filed against the bank.
Mark Lake, a Morgan Stanley spokesman said in a statement that the company was pleased "to have finalized these settlements involving legacy residential mortgage-backed securities matters."
Morgan Stanley previously paid $225 million to resolve claims brought by the National Credit Union Administration arising from losses related to corporate credit unions' purchases of residential mortgage-backed securities; $1.25 billion to resolve claims by Federal Housing Finance Agency for Morgan Stanley's alleged violations of federal and state securities laws; and $86.95 million to resolve federal and state securities laws claims brought by the Federal Deposit Insurance Corporation as receiver on behalf of failed financial institutions.
Morgan Stanley also previously entered into a consent decree with the U.S. Securities and Exchange Commission to pay $275 million to resolve certain residential mortgage-backed securities claims.
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