Tags: Morgan Stanley | mortgage | securitization | bonds

Morgan Stanley Mortgage Securitization Is a Microcosm of Our Economic Malady

By    |   Friday, 30 Aug 2013 07:58 AM

Recently, Morgan Stanley became the first investment bank to be sued by a group of homeowners, who claim they suffered from racial discrimination due to securitization of high-risk mortgage loans, which lead to the financial crisis of 2007-2008.

This action is significant, since the plaintiffs elected to bypass the original lender of the subprime mortgage and target the investment bank responsible for securitizing high-risk loans in neighborhoods that were vulnerable to economic catastrophe. They cite the Fair Housing Act statute as a basis for this action.

Morgan Stanley orchestrated these securitizations as a principal financier of the now-defunct New Century Mortgage Corp. This firm was highly leveraged with a huge concentration of subprime loans. A small drop in asset prices virtually wiped out shareholder equity in very short order.

BlackRock CEO Larry Fink, who has been mentioned as a possible Treasury secretary, suggested the credit bubble was present in 2006 and recognized it would implode. However, he acknowledged his timing of the crisis was grossly inaccurate, according to Businessweek.

Bank regulators are attempting to reduce the probability of this situation and future taxpayer bailouts by placing more financial responsibility on the bondholders. In the future, bondholders may need to accept equity in place of bonds to help finance the company. Equity is not guaranteed a fixed rate of return, as is the case for bonds.

As a result, the risk of purchasing bonds has increased, leading to downgrades of Morgan Stanley's debts. Last year, their rating was slashed to the lowest level in 20 years. In recent weeks, Moody's indicated they might reduce the rating even more, leaving it slightly above junk status, based on a report in The New York Times.

To ameliorate their near death, high-risk behavior, Morgan Stanley has been focusing on wealth management during the past few years. This model is less lucrative but safer, since it relies on steady fees from client assets rather than high-risk trading that requires capital reserves derived from debt.

Toward this end, they are nearly complete with the acquisition of Smith Barney, bringing their total brokers in house to 17,000. However, with their faulty 3D brokerage technology platform, many clients and brokers have not been able to conduct business effectively.

This debacle may have precipitated the exodus of 178 advisers with $24 billion of assets under management during the past year or so, says the Financial Advisor. While this represents less than 2 percent of its $1.7 trillion total assets, it suggests a lack of confidence in the future of the organization.

Mortgage securitization was enabled by complex financial engineering that effectively camouflaged the true risk of the security. As such, these products were successfully marketed to unsuspecting investors, permitting generous income streams to the securitizers, while generating losses for their clients and taxpayers.

Future financial models need to reduce the likelihood of this practice if we are to experience stable, long-term economic growth and prosperity.

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Recently, Morgan Stanley became the first investment bank to be sued by a group of homeowners, who claim they suffered from racial discrimination due to securitization of high-risk mortgage loans, which lead to the financial crisis of 2007-2008.
Morgan Stanley,mortgage,securitization,bonds
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2013-58-30
Friday, 30 Aug 2013 07:58 AM
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