Insider Emails: Wall Street Pushed Bad Detroit Mortgage Loans
Recently disclosed emails and documents give the clearest evidence yet that high-level banking officials pushed subprime mortgage loans knowing some Detroiters couldn't pay them — helping spark a foreclosure crisis that devastated the city during the Great Recession.
The new documents were revealed in a potential class action by African-American Detroit homeowners against Morgan Stanley, one of the nation's largest Wall Street investment firms. The lawsuit, Adkins et al v. Morgan Stanley, alleges the high-risk loans in 2004-07 were racially discriminatory because they "disproportionally impacted" thousands of metro Detroit black borrowers.
Lawyers for five Detroit plaintiffs say the internal bank documents show officials encouraged New Century, a now-bankrupt lender, to push the loans and that Morgan Stanley ignored its normal credit standards so it could pool the mortgages as investments for lucrative fees. The lawsuit seeks unspecified damages.
A Morgan Stanley spokesman declined to comment on the lawsuit, which was filed in 2012. But in its written responses to the suit, the firm denies backing racially discriminatory predatory loans. Morgan Stanley has already agreed in settlements with U.S. government regulators to pay about $1.5 billion for its role in the larger subprime scandal.
In emails in the 2004-07 period, Morgan Stanley staffers referred to the mortgages as "a bunch of scaaaarrryyyy loans!!!!!!," "crap," and "like a trash novel."
As early as October 2005, one Morgan Stanley staffer, Rob Travis, identified as a due diligence manager who looked at the creditworthiness of loans, emailed several Morgan Stanley superiors and staffers about his discomfort over loans being made to borrowers with light credit and no proof of income. "There is not a lot of common sense being used when approving these types of loans," he wrote.
In an internal memo dated April 14, 2006, Steven Shapiro, head of the firm's trading desk, predicted a growing problem with mortgage foreclosures: "We should expect...a good percentage of the borrowers going into extended delinquency/liquidation."
The following January, Shapiro emailed officials at New Century, asking, "What is going on with these loans??????????" A New Century executive emailed back, "You mean besides borrowers who apparently don't have the money to make their mortgage payments? (Sorry to be flip ...)"
The emails and documents suggest Morgan Stanley officials knew what they were buying, and indeed, encouraging New Century to make high-risk loans even as the mortgages were failing.
Morgan Stanley kept buying the loans until the housing crisis broke. New Century filed for bankruptcy in 2007. The crash of the mortgage market pushed tens of thousands of homes in the city into foreclosure in 2008 and beyond.
The plaintiffs' suit also quotes an unidentified Morgan Stanley director of its mortgage unit saying in a radio broadcast in 2008 after the subprime bubble collapsed: "It felt wrong way back when. And I wish we had never done it."
Morgan Stanley is hardly alone in taking blame for the subprime scandal that all but collapsed the U.S. financial system and led to the Great Recession. The U.S. Justice Department has reached settlements with Bank of America, JPMorgan Chase, Citigroup and other Wall Street firms to pay billions of dollars in penalties to settle investigations stemming from their backing of mortgage-backed securities to investors.
To be sure, mortgage loans are a two-way street with borrowers agreeing to payment terms. But the new evidence unsealed in the lawsuit helps answer a central question of the housing crisis about whether high-level bankers knew the full extent of high-risk lending that led to an epidemic of foreclosures in Detroit and other cities.
Some of the Detroit homeowners got New Century mortgages with adjustable rates that started at around 8% but could jump to more than 17% in a few years. And the loans were rife with other risk factors, including balloon payments and prepayment penalties. The lawsuit cites 4,633 potential class members in and around Detroit.
Court documents show that New Century sold a nearly equal number of loans to white and black metro Detroit homeowners in 2004-07 but that 90% of the loans to black borrowers were high cost compared with 79% for white borrowers. Also, about 40% of New Century's high-cost loans in the Detroit region went to neighborhoods that were 70% or more African-American.
If certified as a class action, the lawsuit brought in U.S. District Court in Manhattan could produce damages in the millions of dollars. The federal court could rule on the class status of the case in the next few months. Certifying it as a class action could push Morgan Stanley to settle rather than risk a huge judgment. If the judge denies class-action status, each borrower would have to pursue individual cases, something few could afford.
Marilyn Mullane, executive director of the nonprofit Michigan Legal Services, which is partnering with the American Civil Liberties Union in filing the lawsuit, said the case demonstrates that the high-risk lending that devastated Detroit was orchestrated at the highest levels of Wall Street.
"This crisis was not created by low-income people who got mortgages they couldn't afford," Mullane said. "It didn't originate from borrowers. It's apparent that at much higher levels, decisions were made to create mortgages that had predatory features in them that guaranteed that these mortgages would fail."
The origins of the case go back to 2004-07 when New Century, based in Irvine, Calif., made thousands of high-risk subprime mortgage loans in Detroit and throughout the U.S. Morgan Stanley, based in New York and one of the nation's largest investment banks, bought thousands of the mortgages and pooled them as securities for sale to investors.
Morgan Stanley encouraged New Century to keep up the volume of loans in cities such as Detroit — regardless of how risky those loans were, according to the lawsuit. Morgan Stanley became the top buyer of New Century's mortgages.
The firm had a stake in keeping the loan volume high because it collected fees from bundling the loans and creating mortgage-backed bonds it sold to pension funds and other large buyers. The firm made its profit from fees, so it could be indifferent to the actual performance of the underlying mortgages.
In a deposition given in the case, William McKay, former senior vice president and chief credit officer for New Century, testified that concerns over creditworthiness of the loans being made in Detroit "were kind of overridden by comments, well, if we can sell it, then it can't be a bad loan."
Like any mortgage lender, Morgan Stanley and New Century had credit guidelines that should have denied loans to many, perhaps, most of the borrowers who got subprime mortgages. But those standards were set aside in the rush to create lucrative securities.
"They just kind of steamrolled past those safeguards," said Laurence Schwartztol, attorney for the American Civil Liberties Union Foundation, which filed the lawsuit.
Typical was a loan New Century made to Rubbie McCoy, now in her 40s, a single mother of six children and renting a three-bedroom bungalow near Henry Ford Hospital.
In a whirlwind series of events in July 2006, McCoy's landlord told her she could either buy the house she was renting or move out. The landlord arranged for a New Century loan and drove McCoy to the Southfield office.
"It was really fast," McCoy, a swim instructor with the city's recreation department, told the Free Press last week. "She called me, we went out to Southfield. I can't even remember the office we went to, it was just that fast. Just sign the papers, then we went to another place, sign some more papers. And then that was it. This is your house, your payments are starting next month."
Like other New Century loans that Morgan Stanley bundled for investors, McCoy's loan carried risky features. The adjustable rate started at 10.5% but could adjust as high as 17.75% in a few years, translating into payment shock. And McCoy didn't realize that the lender wasn't setting aside part of her mortgage payments to pay her property taxes, with the result that she fell behind on her taxes, too.
Moreover, the lawsuit alleges, the mortgage broker who arranged McCoy's New Century loan inflated her income by inflating her child support payments from $30 to $100 per week. The appraisal that justified the $79,200 mortgage was unrealistically high.
McCoy quickly fell behind in her payments. "I wrote a letter to the mortgage company. I told them, 'You have a choice. Either help me try to stay in the house, or I walk away and it will look like the house next door, cause they'll rip it apart in a week.'"
McCoy's loan passed among different financial entities until finally she was able to refinance at a more realistic balance — $8,500, or only about 10% of her original balance. She is working to pay down her tax delinquency. She remains in the house with her children.
Asked about how she feels toward Morgan Stanley, she said, "Had it not been for them, the city would still have viable neighborhoods instead of skeleton neighborhoods. It's like a ghost town in some of these neighborhoods."
She added, "And it's just sad to look around and know that [Morgan Stanley] benefited from the loss that all these other people took. You got money. What about us? It's just sad to look around and see it and know that it was orchestrated from up top. It's like a setup for failure. Why would you do that?"
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