The American Civil Liberties Union has accused Morgan Stanley of violating civil rights laws by encouraging a lender to push more expensive and risky mortgages on black neighborhoods in Detroit.
The ACLU and others filed the lawsuit Monday on behalf of five homeowners who took out loans from New Century Mortgage Corp., a subprime lender that has since collapsed.
Morgan Stanley said the allegations, filed in federal court in New York, were "completely without merit."
The lawsuit claims Morgan Stanley pushed New Century to make the risky loans because Morgan made its profit at the start of the process and sold the loans before they could go bad.
The investment bank took the subprime loans from New Century and bundled them into mortgage bonds, which were then packaged into other securities and delivered to big investors all over the world.
Because Morgan Stanley bought more of New Century's loans than any other firm did, it "effectively dictated the types of loans that New Century issued," the suit said. It described the loans as destined to fail.
The plaintiffs argue that Morgan Stanley encouraged New Century to make "stated-income" loans, in which borrowers provided no verification of their income when they applied for mortgages. Those loans allowed mortgage brokers to inflate borrowers' income and make them appear more creditworthy.
The complaint said that in and around Detroit a black borrower was 70 percent more likely to wind up with a high-cost subprime loan from New Century than a white borrower with similar income and financing needs.