The American Civil Liberties Union sued Morgan Stanley on Monday, in what the group said is the first lawsuit against an investment bank alleging racial discrimination over packaging subprime mortgage loans into securities.
The lawsuit alleges Morgan Stanley encouraged a unit of now-bankrupt New Century Financial Corp to target black borrowers disproportionately with loans that had a strong possibility of foreclosure and unjustifiably high costs. Morgan Stanley received significant fees from packaging and selling these loans as securities to institutional investors, while the borrowers faced high risks of default, the ACLU said.
"With this lawsuit, real victims of the subprime lending scandal are stepping forward to hold investment banks like Morgan Stanley accountable for the devastation the banks wrought in their lives and in our economy," ACLU Executive Director Anthony Romero said in a statement.
A Morgan Stanley spokeswoman had no immediate comment on the lawsuit.
The complaint was filed in U.S. District Court in Manhattan on behalf of five Detroit residents. It alleges that Morgan Stanley went beyond the traditional role of an investment bank by helping to fund loans made by New Century, setting loan volume goals and establishing terms of the loans.
The ACLU asked the court to certify the case as a class action. It said as many as 6,000 black homeowners in the Detroit area may have suffered similar discrimination as a result of being offered loans that many could not afford.
The alleged practice twists past claims that banks engaged in "red-lining," or refusing to provide loans and other services in low-income areas.
"These loans were mass produced and they were built to order, not to serve homeowners," Elizabeth Cabraser, a co-counsel for the plaintiffs, said at a news conference Monday morning. "It's reverse red-lining. It violates the Fair Housing Act."
Discriminatory practices connected to the securitization process were endemic during the last decade throughout much of the financial services industry and across the nation, the ACLU said.
Critics of securitization, in which banks package loans into securities for sale to sophisticated investors, say it allows banks to be reckless in their credit policies because they do not end up holding the loans. Advocates say that by removing loans from bank balance sheets, it allows them to stimulate the economy by extending credit across a variety of sectors.
Trillions of dollars of mortgage, credit card, automobile and other consumer loans have been securitized and sold to investors. Many of the home loans bought by the banks are insured by agencies such as the Federal Home Loan Mortgage Corp. , or Freddie Mac, and Federal National Mortgage Association , or Fannie Mae.
The ACLU lawsuit follows a spate of new litigation against Wall Street by U.S. federal and state authorities over banks' roles in triggering the financial crisis that began more than four years ago.
JPMorgan was sued by New York State Attorney General Eric Schneiderman for alleged subprime mortgage abuses at an investment bank that it purchased during the financial crisis. The U.S. attorney in Manhattan filed fraud charges against Wells Fargo Corp two weeks ago for a "reckless pattern" of making questionable home loans that allegedly cost government hundreds of millions of dollars in insurance settlements.
Massachusetts earlier sued Morgan Stanley for securitizing home loans, alleging violations of a state consumer protection law. The ACLU said that case did not address the issue nationwide nor link the alleged abusive practices to discriminatory policy.
Lawyers for the plaintiffs also include the National Consumer Law Center and Lieff Cabraser Heimann & Bernstein, a San Francisco-based law firm.
The case is Beverly Adkins et al v Morgan Stanley, U.S. District Court for the Southern District of New York, No. 12-7667.
(Reporting By Jed Horowitz, additional reporting by Emily Flitter; Editing by Martha Graybow and Maureen Bavdek)