Morgan Stanley reached a $2.6 billion settlement with Justice Department

Investment bank Morgan Stanley announced on Wednesday that it has reached a $2.6 billion settlement with the Justice Department over its role in the mortgage bubble. Bubbles occur when prices rise far above their intrinsic value and then plunge (burst).

In 2014 the bank paid $1.25 billion to the Federal Housing Finance Authority to resolve claims of selling bad mortgages to Fannie Mae and Freddie Mac.

A number of other banks have also been hit by similar settlements. Last year Bank of America agreed to pay $16.7 billion and JPMorgan Chase reached a $13 billion settlement in 2013.

Compared to many other big banks Morgan Stanley wasn’t as heavily involved in the mortgage-backed securities market.

However, it still played a role nonetheless and authorities are cracking down on them hard. The company purchased mortgages from subprime mortgage originators and packaged them into securities, which the bank then sold off to investors. A lot of these securities ended up becoming worthless junk. Subprime mortgages are loans given to individuals with low credit ratings.

The Justice Department did not issue a statement on the agreement.

However, Morgan Stanley said in a regulatory filing that the $2.6 billion will go to “resolve certain claims” against the bank related to operations in its mortgage business.

It also warned that “there can be no assurance that the company and the civil division will agree on the final documentation of the settlement.

A big blow to the bank that is struggling to improve profitability

The settlement comes as a big blow to the company. Since the financial crisis, it has struggled to improve profitability and lost market share to its competitors and the settlement will eat into its earnings.

The bank is going to restate its 2014 results because of the settlement. It is increasing its legal reserves by $2.8 billion, which will decrease its full-year earnings to $1.61 a share from $2.96 a share – a drop of over 40 percent.

Morgan Stanley shares closed down fractionally at $36.59 in Wednesday trading.

Only one bank left in the Justice Department’s mortgage bubble crackdown

Goldman Sachs is now the last major Wall Street player that has not yet reached an agreement with federal authorities over its role in the financial collapse.