Morgan Stanley Reaches $2.6 Billion Settlement Over Mortgage-Backed Securities

Morgan Stanley, one of two remaining large independent investment banks, said today that it had reached a preliminary $2.6 billion settlement with the Justice Department over its dealings with mortgage-backed securities before the financial crisis.

The company said in a filing today that the civil division of the Justice Department and the U.S. Attorney for the Northern District of California had intended to bring civil charges against the bank, and it has increased its reserves for legal losses by $2.8 billion. The bank said that while an agreement had been reached, “there can be no assurance that the Company and the Civil Division will agree on the final documentation of the settlement.”

Because Morgan Stanley has yet to file its form 10-Q for the fourth quarter, the charge from the settlement will hit its net income for last year. When Morgan Stanley preliminarily announced its fourth-quarter results, it said that it had set aside $284 million to deal with “legacy residential mortgage legal expenses.” But the $2.8 billion it has now set aside still outpaces the $2.6 billion it has agreed to with the Justice Department.

While Morgan Stanley didn’t say exactly how the money will be divvied up, there is a clue in looking at past settlements. When other big banks have settled civil claims over their marketing and sales of mortgage-backed securities, they tend to pay out to both the Justice Department and some states whose attorneys general have pursued investigations of them. In the $7 billion settlement with Citigroup, for example, the bank paid a $4 billion civil penalty to the Justice Department and almost $300 million to five states.

In a regulatory filing in November, Morgan Stanley said that the Virginia Attorney General had filed a civil suit against it over sales of mortgage securities to the Virginia Retirement System, which administers pension plans for state employees, and Illinois’ Attorney General had sent it a letter alleging that Morgan Stanley had “knowingly made misrepresentations related to RMBS” sold to pension funds affiliated with the state and demanded Morgan Stanley pay $88 million.

Morgan Stanley is the latest bank to shell out for a large settlement to resolve a Justice Department civil investigation of its pre-financial-crisis creation and marketing of mortgage-backed securities. The bundles of home loans packaged into bonds and sold to investors were central to the financial meltdown and recession that followed. Bank of America paid $16.65 billion to settle with the Justice Department and other regulators, while JPMorgan Chase paid $13 billion.

The Wall Street Journal reported earlier this week that Goldman Sachs was “inching closer to resolving U.S. claims” that it had “misled investors in mortgage bonds that plummeted in value during the financial crisis.”

Goldman said in a regulatory filing that it had raised its estimate for legal losses from $2.5 billion to $3 billion. Goldman said in the filing that the U.S. Attorney for the Eastern District of California had sent the bank a letter “stating in connection with potentially bringing a civil action that it had preliminarily concluded that the firm had violated federal law in connection with its underwriting, securitization and sale of residential mortgage-backed securities.”