By Andrew Grossman and Christina Rexrode
WASHINGTON--As the seeds of the financial crisis were being
sown, a Citigroup Inc. trader sent an internal email warning about
the poor quality of mortgages the bank was packaging into
securities and selling to investors.
"We should start praying," the trader wrote in the email.
On Monday, the bank agreed to pay $7 billion, including a $4
billion civil penalty to the Justice Department, $500 million to
the Federal Deposit Insurance Corp. and several states, and $2.5
billion earmarked for "consumer relief," to settle the U.S.
government's allegations it knowingly sold shoddy mortgages ahead
of the crisis.
The settlement doesn't absolve Citigroup or its employees from
facing any possible criminal charges, Attorney General Eric Holder
said. He declined to say whether the government was pursuing
criminal charges.
Citigroup, in a statement of facts, admitted to repeatedly
brushing aside warnings from both inside and outside the bank that
many of the loans it had packaged had serious problems and
concealing that information from investors.
Mr. Holder said the bank sold mortgage-backed securities with
widespread defects and described Citigroup's conduct as
"egregious."
"The bank's activities contributed mightily to the financial
crisis that devastated our economy in 2008," Mr. Holder said.
"Taken together, we believe the size and scope of this resolution
goes beyond what could be considered the mere cost of doing
business."
The Justice Department said that when a third-party "due
diligence vendor" turned up a significant portion of mortgages that
were found to be low-grade, such as missing key documents or made
to borrowers with poor credit, the bank often chose not to reject
the loans. Instead, Citigroup engaged in a sleight of hand, in
which it reclassified the loans as better-performing, the Justice
Department said, and then misrepresented their quality to
investors.
"Citigroup employees often personally ordered the due diligence
firms to change the loan grades...from reject to accepted," said
U.S. Attorney John Walsh of Colorado, whose office helped lead the
investigation.
Such conduct helped fuel the Justice Department's push for a
hefty fine over the objections of Citigroup, which had argued that
it shouldn't have to pay so much because it was a relatively small
player in the mortgage-securities market.
In all, the Justice Department uncovered 45 mortgage-security
deals in 2006 and 2007 in which the bank made misrepresentations
about the quality of the underlying loans, said Loretta Lynch, the
U.S. attorney from Brooklyn.
"We believe that this settlement is in the best interests of our
shareholders, and allows us to move forward and to focus on the
future, not the past," said Citigroup Chief Executive Officer
Michael Corbat.
The Citigroup penalty is the latest enforcement action stemming
from the Justice Department's probe of banks' precrisis sales of
residential mortgage-backed securities.
Bank of America Corp. is in discussions to pay at least $12
billion to settle similar civil charges by the Justice Department
and some states, though the bank and the government remain billions
of dollars apart, according to people familiar with the talks. The
bank is offering $12 billion, according to the people. The bank has
already paid $6 billion to settle separate allegations about its
mortgage-backed securities by the Federal Housing Finance Agency.
J.P. Morgan Chase & Co. settled similar allegations for $13
billion last year.
The Justice Department has also extracted large penalties for
nonmortgage-related conduct, including an $8.9 billion settlement
from BNP Paribas SA over the French bank's efforts to circumvent
U.S. sanctions on various countries and a $2.6 billion penalty
levied on Credit Suisse Group AG related to its effort to help
Americans evade taxes. BNP and Credit Suisse pleaded guilty to
criminal charges. J.P. Morgan acknowledged the misconduct. Bank of
America has neither admitted nor denied the allegations.
The government's description of wrongdoing at Citigroup closely
mirrors conduct outlined in the Justice Department's settlement
with J.P. Morgan. In both cases, the banks acknowledged repeatedly
giving investors misleading information about mortgages underlying
the securities. In many cases, those mortgages didn't meet internal
underwriting guidelines but were included in packages and sold to
investors.
Citigroup bought some of its loan pools from other companies,
including Countrywide Financial Corp., which was later bought by
Bank of America, and New Century Financial, a subprime lender that
later went bankrupt.
In a conference call with reporters, Citigroup Chief Financial
Officer John Gerspach declined to comment on whether the bank had
asked for release from any potential criminal charges as part of
the settlement.
Citigroup's penalty, unlike J.P. Morgan's, releases it from
potential liability to the Justice Department for collateralized
debt obligations, or CDOs, not just mortgage securities. The
settlement covers residential mortgage-backed securities and CDOs
issued in the run-up to the financial crisis, from 2003 to 2008.
Citigroup was a major player in CDOs, which are pools of mortgages
and other debts that are packaged and sold to investors.
Separately, the bank faces a continuing probe of whether its
Banamex unit in Mexico did enough to stop suspected money
laundering in suspicious transactions along the U.S.-Mexico border.
Also, in February, it disclosed an alleged accounting fraud in its
Mexico unit.
Meanwhile, Citigroup said second-quarter profit plunged 96% as
the bank took a $3.8 billion charge tied to the settlement. On
Monday, shares of the bank ended 3% higher, at $48.42, as results
beat analyst estimates. The bank's shares are down 7.1% this
year.
In addition to Citigroup's problems with Banamex, the Federal
Reserve in March rejected its stress-test request for a higher
dividend and share buyback, citing a need for the bank to improve
its overall risk-management systems.
Citigroup's $7 billion agreement comes after a long negotiation.
The bank in May had opened with an offer to pay $363 million in
cash, plus more for consumer relief. The Justice Department came
back with a far higher number: close to $12 billion, including
consumer relief.
The negotiations were seen as a flash point for both Mr. Corbat,
who was given the top job in 2012 with a mandate to improve
relations with the government, and for Mr. Holder, who has faced
criticism from Congress that the Justice Department has been too
soft on banks.
Write to Christina Rexrode at christina.rexrode@wsj.com and
Andrew Grossman at andrew.grossman@wsj.com
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