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As reported in the Feb. 5 Wall Street Journal, Morgan Stanley agreed to settle a bond suit with the Federal Housing Finance Agency (FHFA) for $1.25 Billion.  This represents the largest legal expense for Morgan Stanley related to the fallout from the financial crisis.

This lawsuit was commenced by the FHFA in 2011 and targeted 18 of the largest financial institutions in the world.  FHFA charged that these banks sold more than $200 billion in securities to Fannie Mae and Freddie Mac without adequately disclosing the risks. The materials that were sent to Fannie and Freddie misrepresented the quality of loans backing those bonds.  Fannie and Freddie buy mortgages from banks and then sell these loans as securities. They are not direct lenders.

Morgan Stanley became the eighth financial entity to settle these claims. It was the third largest settlement behind Deutsche Bank AG, which agreed to pay $1.93 billion in December and J.P. Morgan Chase, which reached a $4 billion settlement in October.

These settlements have followed several rulings by U.S. District Judge Denise Cote that have been adverse to the banks. In December, she ruled against the bank’s potential defenses against state securities-law claims brought by the FHFA. These rulings could potentially increase the amount of money the Government could recover at trial.  In addition, there have been favorable Federal Appeals Court rulings for the Government regarding filing deadlines and standing.

In the cases that have not settled, the FHFA suit against Bank of America and two firms it acquired in 2008, Countrywide Mortgage and Merrill Lynch and Co., is for over $57.4 billion in securities. Merrill Lynch's case is set for trial in June.