The US investment banking giant Morgan Stanley took a $1.8bn (£1.15bn) hit yesterday as it settled a long-running legal battle over toxic sub-prime debt.
The bank's two-year dispute with bond insurer MBIA centres on mortgage-backed bonds which Morgan Stanley insured with MBIA in 2008.
MBIA ran into trouble during the financial crisis, sparking fears at Morgan Stanley it would go bust without stumping up insurance payouts on the bonds. The investment bank tried to hedge this risk by buying credit default swaps on MBIA, in effect betting against the company. But a recovery in MBIA's fortunes since the financial crisis left Morgan Stanley nursing more than $3bn in losses since 2007 on its exposure to MBIA and other bond insurers since 2007.
Morgan Stanley joined a consortium of 17 banks suing MBIA after a restructuring of the insurer which they claimed would have an impact on its ability to pay out on insurance contracts, but MBIA promptly counter-sued the banks for not doing proper due diligence.
Today's settlement sees MBIA pay $1.1bn to Morgan Stanley, which is writing down the value of its $2.9bn mortgage-backed bonds to nothing and cancelling the CDS contracts. Although the firm will take a $1.8bn blow to profits, removing the riskier assets from its balance sheets frees $5bn in capital.
Its chief executive James Gorman, above, said: "This settlement is consistent with our efforts to build capital and de-risk the balance sheet."