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Damning court filings show Morgan Stanley pushed risky subprime mortgage lending

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  1. Court filings say Morgan Stanley, a major Wall Street bank, pushed subprime lender New Century into making riskier and riskier mortgage loans, the New York Times reports.
  2. The filings include damning emails, showing that Morgan Stanley employees knew about and even joked about some borrowers' inability to pay on their mortgages.
  3. The Justice Department is now investigating the connection between Morgan Stanley and New Century.
  4. The fines further tarnish the reputation of a big bank that, despite its heavy involvement in mortgage-backed securities, until recently had few crisis-related legal troubles.

Subprime buyers and sellers

At the height of the pre-crisis housing bubble, in 2006, New Century was the nation's second-largest subprime mortgage originator, and Morgan Stanley was regularly the biggest buyer of the company's subprime mortgages. New Century made the loans, which Morgan Stanley then bought and repackaged into mortgage-backed securities, which it in turn sold to investors. Morgan Stanley's position as one of New Century's biggest customers helped give the bank heavy influence into the lender's practices, the Times writes. (Now defunct, New Century filed for Chapter 11 bankruptcy in 2007.)

An internal Morgan Stanley report directly stated that the bank was "involved in almost every strategic decision that New Century makes in securitized products," the Times reports.

Morgan Stanley encouraged irresponsible lending

Among the filings was evidence of employees' knowledge of the poor quality of these mortgages. Due diligence executive Pamela Barrow joked in an email about "first payment defaulting straw buyin' house-swappin first time wanna be home buyers."

In addition, when lower-ranking due diligence employees tried to alert her to the bad mortgages Morgan Stanley was buying, Barrow shrugged them off.

"good find on the fraud :)," she wrote to one, adding that she would no longer be using his services.

Morgan Stanley, for its part, maintains in court filings that there is no evidence that it controlled New Century's practices.

The filings came from a 2012 lawsuit in which the ACLU accused New Century of discriminatory lending practices.

The origins of the financial crisis

This isn't just a big deal because it's another instance of a big bank being accused of wrongdoing in the run-up to the crisis. It's also a clear illustration of how Wall Street banks helped cause the crisis by encouraging subprime lenders to make risky loans.

In addition, it's another black mark for Morgan Stanley, which for a period after the crisis had a relatively clean record with the federal government for its conduct during the financial crisis. As Fortune's Stephen Gandel reported in August 2013, at that point, Morgan Stanley was unique among big banks in that it hadn't paid a federal, crisis-related fine.

But legal bills have racked up for the bank. Altogether, it reported it paid nearly $2 billion in legal fees in 2013, almost four times what it paid in 2012, the Wall Street Journal reports. Increased legal fees have repeatedly taken a bite out of the company's earnings, as the Wall Street Journal reported in August. And in July,  the SEC charged Morgan Stanley with misrepresenting the delinquency statuses of mortgage-backed securities to investors. The bank settled for $275 million. (For a closer, concise look at all the SEC's response to the crisis, the agency maintains a running list of all the enforcement actions it has taken in relation to the crisis.)

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