California Sues Banking Giant

investment-bankingThe state of California sued investment banking major Morgan Stanley over losses suffered by the state’s public pension funds when the housing market crashed in 2008. The lawsuit accused the bank of glossing over the risks in toxic residential mortgage-backed securities and “structured investment vehicles” it had marketed between 2004 and 2007.

Kamala Harris, the state’s attorney general, accused Morgan Stanley of violating California’s False Claims Act and various state securities laws by misrepresenting the risks involved in complex investments, which caused the California Public Employees’ Retirement System (CalPERS) and the California State Teachers Retirement System to lose hundreds of millions of dollars. “Morgan Stanley’s conduct in this case evidenced a culture of greed and deception that helped create a devastating economic crisis and crippled California’s budget,” said Attorney General Harris in a statement Friday. Morgan Stanley said it intended to fight the lawsuit.

Filed in San Francisco Superior Court, the lawsuit did not specify the amount of financial loss to the two pension funds. However, previous lawsuits over the same investments had reportedly estimated a combined loss of more than $1 billion, a large part of which was borne by CalPERS. Apart from Morgan Stanley, CalPERS has also sued other investment banks to recover its losses from a series of deals known as “structured investment vehicles,” in which a diversified portfolio of mortgages and other consumer loans were bundled together and sold to state funds. Harris has accused Morgan Stanley and other banks of hiding the fact that many of the loans were going into default, and also of encouraging credit rating agencies to award unjustifiably high ratings to attract investors. This year, both Standard & Poor’s and Moody’s Investors Service agreed to settle claims in California for a combined $255 million.

Morgan Stanley reached a $3.2 billion with state and federal authorities in the U.S. over its role in the 2008 subprime mortgage crisis. The deal comes less than a month after Goldman Sachs agreed to shell out over $5 billion to resolve claims stemming from securitization and sale of mortgage-backed securities between 2005 and 2007. “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,” New York Attorney General Eric Schneiderman said, in a statement released Thursday. “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.” The $3.2 billion deal represents an increase from the $2.6 billion that Morgan Stanley agreed to pay last year. Under the terms of the deal, New York will receive $550 million of the $3.2 billion settlement — $400 million worth of consumer relief and $150 million in cash. The settlement marks one of the last deals connected to sale of subprime mortgage-backed Collateralized Debt Obligations (CDOs) — a practice that eventually triggered the 2008 financial crisis.

So far, in addition to Goldman Sachs and Morgan Stanley, Bank of America and JPMorgan Chase have also agreed to pay billions of dollars for misleading investors about the quality of the CDOs and the risks associated with the underlying loans. Even though Morgan Stanley acknowledged that it knew the mortgages were risky, and that it had increased the “acceptable risk level” for loans in its pool of securitized mortgages, the bank’s settlement is far less than that of the Bank of America, which, in 2014, agreed to pay a record $16.6 billion for its role in triggering the financial crisis. This is partly because Morgan Stanley did not issue mortgages to home buyers it suspected would not be able to pay them. The announcement of the deal comes just days after the Wall Street bank reported a net revenue of $7.7 billion in the fourth quarter of 2015, and earnings of $753 million — compared to a loss of $1.75 billion the year before.

So far this year, the bank’s shares on the New York Stock Exchange have dropped nearly 32 percent, while the NYSE Composite Index has fallen 11 percent.