Case 1:12-cv-07667-VEC-GWG Document 187-84 Filed 10/23/14 Page 1 of 181 Exhibit 84: Expert Report of Ian Ayers Previously filed under seal (Docket No. 131) Case 1:12-cv-07667-VEC-GWG Document 187-84 Filed 10/23/14 Page 2 of 181 UNITED STATES DISTRICT COURT SOUTHERN DISTRICT OF NEW YORK ) BEVERLY ADKINS, CHARMAINE WILLIAMS, ) REBECCA PETTWAY, RUBBIE McCOY, ) WILLIAM YOUNG, on behalf of themselves and all ) others similarly situated, and MICHIGAN LEGAL ) SERVICES, ) ) Plaintiffs, ) Case No. 1:12-cv-7667-VEC ) v. ) CLASS CERTIFICATION ) REPORT OF IAN AYRES MORGAN STANLEY, MORGAN STANLEY & ) CO. LLC, MORGAN STANLEY ABS CAPITAL I ) INC., MORGAN STANLEY MORTGAGE ) CAPITAL INC., and MORGAN STANLEY ) MORTGAGE CAPITAL HOLDINGS LLC, ) ) Defendants. ) ) Case 1:12-cv-07667-VEC-GWG Document 187-84 Filed 10/23/14 Page 3 of 181 -2- TABLE OF CONTENTS I. Introduction ..........................................................................................................................4 II. Qualifications .......................................................................................................................5 III. Summary of Conclusions .....................................................................................................7 IV. Background on Statistical Analysis of Racial Disparities .................................................12 A. Mortgage Industry Overview .................................................................................12 1. Overview ....................................................................................................12 2. African Americans Often Have Been Shown to Receive Less Favorable Loan Terms than Whites with Similar Risk Characteristics through Lenders’ Reverse Redlining Practices .......................................................15 B. Introduction to Testing for Discrimination ............................................................18 C. Tests for Disparate Impact Are Amenable to Aggregate Statistical Analysis .......18 V. A Statistical Analysis of Morgan Stanley’s Data Shows Evidence of Adverse Impact by Race....................................................................................................................................22 A. Overview of New Century and Morgan Stanley Data ...........................................22 1. Racial Demographics of New Century’s Borrowers .................................27 2. Loan Characteristics Included in Morgan Stanley and New Century’s Data ............................................................................................................31 B. Identifying Combined-Risk and High-Cost Loans ................................................34 C. Mean Comparisons Show that African-American Borrowers Were More Likely to Receive Combined-Risk Loans than White Borrowers with Similar Risk Characteristics ........................................................................................................41 D. Regression Models Show that African-American Borrowers Were More Likely to Be Placed in Combined-Risk Loans and High-Cost Loans ...............................45 VI. Analysis of The Named Plaintiffs’ Loans ..........................................................................53 VII. Conclusion .........................................................................................................................54 Appendix 1: Materials Relied Upon ..............................................................................................56 Appendix 2: Curriculum Vitae of Ian Ayres ..................................................................................60 Appendix 3: Cases in Which Ian Ayres Has Testified or Written a Disclosed Report .................84 Appendix 4: Comparing New Century Race & Ethnicity Codes with Public HMDA Data .........88 Appendix 5A: Summary Statistics for New Century’s 2004-2007 Loan Originations, All New Century Loans, Nationwide ...............................................................................................93 Appendix 5B: Summary Statistics for New Century’s 2004-2007 Loan Originations, Morgan Stanley Purchases, Nationwide ..........................................................................................98 Case 1:12-cv-07667-VEC-GWG Document 187-84 Filed 10/23/14 Page 4 of 181 -3- Appendix 5C: Summary Statistics for New Century’s 2004-2007 Loan Originations, All New Century Loans, Detroit Region ........................................................................................103 Appendix 5D: Summary Statistics for New Century’s 2004-2007 Loan Originations, Morgan Stanley Purchases, Detroit Region ...................................................................................108 Appendix 6A: Odds Ratio Results of Combined-Risk Loan Logistic Regressions, All New Century Loans, Nationwide .............................................................................................114 Appendix 6B: Odds Ratio Results of Combined-Risk Loan Logistic Regressions, Morgan Stanley Purchases, Nationwide ........................................................................................122 Appendix 6C: Odds Ratio Results of Combined-Risk Loan Logistic Regressions, All New Century Loans, Detroit Region ........................................................................................130 Appendix 6D: Odds Ratio Results of Combined-Risk Loan Logistic Regressions, Morgan Stanley Purchases, Detroit Region ...................................................................................138 Appendix 7A: Odds Ratio Results of High-Cost Loan Logistic Regressions, All New Century Loans, Nationwide ...........................................................................................................146 Appendix 7B: Odds Ratio Results of High-Cost Loan Logistic Regressions, Morgan Stanley Purchases, Nationwide .....................................................................................................154 Appendix 7C: Odds Ratio Results of High-Cost Loan Logistic Regressions, All New Century Loans, Detroit Region ......................................................................................................162 Appendix 7D: Odds Ratio Results of High-Cost Loan Logistic Regressions, Morgan Stanley Purchases, Detroit Region ................................................................................................170 Appendix 8: Notes on Regression Models in Appendices 6 & 7 ................................................178 Case 1:12-cv-07667-VEC-GWG Document 187-84 Filed 10/23/14 Page 5 of 181 -4- I. INTRODUCTION 1. I have been asked by counsel for Beverly Adkins, Charmaine Williams, Rebecca Pettway, Rubbie McCoy, and William Young, on behalf of themselves and all others similarly situated, (“Plaintiffs”) to analyze Plaintiffs’ claims that Morgan Stanley’s loan purchasing, pooling, and securitization policies adversely impacted African-American borrowers. I have reviewed the Complaint for this case filed October 15, 2012 in the Southern District of New York.1 This and other materials that I rely upon in forming my opinions are listed in Appendix 1. 2. Plaintiffs allege that Morgan Stanley discriminated against African-American borrowers through its policies with respect to its orchestration of mortgages originated by New Century Mortgage Company (“New Century”). More specifically, plaintiffs have alleged that Morgan Stanley “effectively dictated the types of loans that New Century issued, requiring as a condition of the companies’ lucrative business relationship that a large percentage of New Century’s loans have certain dangerous characteristics.”2 These loans were especially hazardous to borrowers due to their combination of multiple high-risk features.3 Counsel for plaintiffs have asked me to examine whether these loans with multiple high-risk features were more likely to have been imposed on African-American borrowers than white borrowers. These allegations have been brought pursuant to the Fair Housing Act (FHA).4 3. Plaintiffs have brought an action on behalf of the following class: “All African- American individuals who, between 2004 and 2007, resided in the Detroit region (as defined 1 Class Action Complaint, Adkins v. Morgan Stanley, No. 1:12-cv-7667-HB (S.D. N.Y.) [hereinafter Complaint]. 2 Id. ¶2. 3 Id. ¶3. 4 Id. ¶¶8, 236-273. Plaintiffs originally brought claims under the Equal Credit Opportunity Act (ECOA) and Michigan’s Elliot-Larsen Civil Rights Act (ELCRA), but the Court granted Defendant’s motion to dismiss the ECOA and ELCRA claims. Opinion & Order, Adkins v. Morgan Stanley, No. 1:12-cv-7667-HB (S.D. N.Y.) (July 25, 2013). Case 1:12-cv-07667-VEC-GWG Document 187-84 Filed 10/23/14 Page 6 of 181 -5- herein) and received Combined-Risk Loans from New Century”5 (hereinafter referred to as the “Class” or “Class Members”). A “Combined-Risk Loan” is defined in the Complaint as a loan that meets “the definition of high-cost loan under HMDA and also contain two or more of the following high-risk terms: (a) the loan was issued based upon the ‘stated income,’ rather than the verified income, of the borrower; (b) the debt-to-income ratio exceeds 55%; (c) the loan-to-value ratio exceeds or equals 90%; (d) the loan has an adjustable interest rate; (e) the loan has ‘interest only’ payment features; (f) the loan has negative loan amortization features; (g) the loan has ‘balloon’ payment features; and/or (h) the loan imposes prepayment penalties.”6 The “Detroit region” is defined as the nine counties