Black Detroit Homeowners Sue Morgan Stanley Over Mortgages

by Frederick H. Lowe
Five African-American homeowners on Monday sued the investment banking firm Morgan Stanley, charging that the company encouraged one of the nation’s worst subprime lenders to issue mortgages to borrowers who were certain to default because of the loans’ high debt-to-income ratio. The debt-to-income ratio is the percentage of a consumer's monthly gross income that goes toward paying debts.

Morgan Stanley, however, profited from the sale of the high-risk mortgages issued by the now defunct New Century Mortgage Co. by packaging, or securitizing, the loans and selling them to Wall Street firms for considerable fees, the lawsuit alleges.

"Because its receipt of fees had little or no connection to how the securities performed....Plaintiffs in the case received loans that were not designed to be economically viable. Rather, those loans extracted short-term fees and costs while diminishing their wealth and exposing them to elevated risk of foreclosure,” lawyers for the American Civil Liberties Union said.

The black homeowners, all of whom live in Detroit, filed the lawsuit in the United States District Court for the Southern District of New York, where Morgan Stanley is headquartered.

The lawsuit, which was filed by ACLU, Michigan Legal Services, National Consumer Law Center and Lieff Cabraser Heimann & Bernstein, a San Francisco-based law firm, seeks class-action status because as many as 6,000 black homeowners in the Detroit area may have suffered similar discrimination at the hands of Morgan Stanley.

"We believe these allegations are completely without merit and plan to defend ourselves vigorously,” Mary Claire Delaney, executive director of Morgan Stanley Corporate Communications, said in a response to the suit.

The lawsuit is one of many in which African-American homeowners and the the U.S. Justice Department have sued banks and other financial institutions, charging that they sold high-interest subprime mortgages to black homeowners. Many of the homeowners defaulted on the loans, and the financial institutions foreclosed on the mortgages, leaving black neighborhoods with blocks of boarded up and abandoned buildings.

The lawsuit notes, however, that the lawsuit is the first case in which a prospective class of victimized homeowners is suing an investment bank directly instead of suing New Century, the subprime lender.

Morgan Stanley and New Century had a symbiotic relationship. Morgan Stanley financed and purchased New Century’s loans so they could be packaged and sold to Wall Street investors.

“Morgan Stanley went well beyond the role of a passive consumer or conventional securitizer in its relationship with the New Century,” the lawsuit alleges. “Morgan Stanley provided crucial funding to New Century that facilitated New Century in making mortgage loans.”

Morgan Stanley said it would purchase $2 billion dollars worth of loans each month from New Century, according to the lawsuit.

In 2008, the U.S. Office of the Comptroller of the Currency listed New Century as one of the 10 worst subprime lenders based on its high number of foreclosures in 10 metropolitan areas issued between 2005 and 2007.

Morgan Stanley pushed New Century to issue Combined-Mortgage Loans, which met the definition of high-cost loans under the Home Mortgage Disclosure Act: The loans were issued based on “stated income,” rather than verified income of the borrower. The loan had an adjustable interest rate; interest-rate only payment features; negative loan-amortization features and balloon-payment features. The loans imposed prepayment penalties and the debt-to-income ratio exceeds 55 percent.

The plaintiffs charged that New Century employees falsified income data often over the their objections.

Rubbie McCoy, one of the named plaintiffs, had falsified information on her loan application, although she objected. The broker also omitted critical details, including that after two years, New Century no longer would pay the taxes or insurance on her mortgage. The other plaintiffs are Beverly Adkins, Charmaine Williams, Rebecca Pettway, William Young and Michigan Legal Services.

According to the lawsuit, Morgan Stanley agreed to pay New Century above-market prices for a steady supply of mortgages. Morgan Stanley purchased 45 percent of the loans from New Century that had excessive debt-to-income ratios.

“Morgan Stanley’s staff agreed that a debt-to-income of ratio of 55 percent meant that the borrower’s income was fully allocated to paying debt, after accounting for all of a borrower’s normal expenses,” the lawsuit charges. “Nevertheless, the same employee stated, Morgan Stanley routinely purchased loans with debt-to-income ratios of 60 percent or higher for securitization, a feature of many loans that Morgan Stanley purchased from New Century.” The debt-to-income ratio is a primary bellwether of a borrower's ability to meet the loan's terms.

The lawsuit charges Morgan Stanley violated the Fair Housing Act, the Equal Credit Opportunity Act and the Michigan Elliott-Larsen Civil Rights Act.