By Christina Rexrode and Andrew Grossman
Citigroup Inc. will pay $7 billion to settle the U.S.
government's accusations the bank misled investors about the
quality of mortgage securities it sold in the run-up to the
financial crisis.
The Justice Department on Monday said Citigroup knowingly sold
mortgage-backed securities with loans containing "material defects"
and concealed that information from investors in what Attorney
General Eric Holder described as "egregious" misconduct that helped
fuel the 2008 financial crisis.
The settlement, which includes a $4 billion civil penalty,
doesn't absolve Citigroup or its employees from facing any possible
criminal charges, Mr. Holder said. He declined to say whether the
government was pursuing criminal charges.
Citigroup admitted to many of its misdeeds "in great detail" the
Justice Department said. A statement of facts released by the
government--and agreed to by the bank--detailed a pattern of the
bank repeatedly ignoring its own red flags about subpar mortgages
and making misrepresentations to investors about the quality of
loans being securitized.
On several occasions, bank employees learned that significant
percentages of mortgage loans reviewed as part of its "due
diligence" were defective. One Citigroup trader, in an internal
email cited by the government, stated the bank "should start
praying" because so many of the loans were likely to go sour. "It's
amazing that some of these loans were closed at all," the email
stated.
Despite knowing the underlying mortgages were problematic and
might wind up in default, Citigroup pooled the loans into
residential-mortgage backed securities and sold them to investors,
the government said.
"Citigroup employees often personally ordered the due diligence
firms to change the loan grades...from reject to accepted," said
Colorado U.S. Attorney John Walsh.
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.
"Our teams found that the misconduct in Citigroup's deals
devastated the nation and the world's economies, touching
everyone," Ms. Lynch said, adding the harmed investors included
public pension funds, states, cities, religious charities, and
hospitals.
"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."
In a call with reporters Monday morning, 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.
"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 in a statement.
To resolve the probe, Citigroup will pay a $4 billion civil
penalty to the Justice Department, plus $500 million to the Federal
Deposit Insurance Corp. and several states. Citigroup also agreed
to spend $2.5 billion on "consumer relief," where it will get
credit for modifying mortgages for struggling homeowners and
similar actions.
The pending settlement and other legal problems have been an
overhang for the bank. Citigroup's penalty, unlike a similar
settlement between the Justice Department and J.P. Morgan Chase
& Co. in November, releases it from potential liability for
CDOs, or collateralized debt obligations, 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.
The bank has "now resolved substantially all of our legacy RMBS
and CDO litigation," Mr. Corbat said in his statement.
Still, the bank faces a continuing probe of whether its Banamex
USA unit did enough to stop suspected money laundering in
suspicious transactions along the U.S.-Mexico border.
Citigroup also released its second-quarter earnings Monday, with
the bank disclosing its profit dropped 96% in the quarter thanks in
part to a pretax charge of about $3.8 billion related to the
settlement. Still, the company's earnings came in better than
analysts' expectations.
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," or money the bank will set
aside to help customers in financial trouble. The Justice
Department came back with a far higher number: $12 billion,
including consumer relief.
The bank had argued that it shouldn't have to pay so much
because it was a relatively small player in the mortgage-securities
market. But the Justice Department lawyers saw Citigroup's conduct
as so egregious that it merited a high penalty.
At one point in mid-June, the government came to within a day of
filing a lawsuit against the bank.
Citigroup is the second of the U.S. megabanks to settle with the
government over mortgage securities. J.P. Morgan settled similar
charges in November for $13 billion. Talks between the government
and Bank of America Corp. are under way.
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
constant criticism that his Justice Department has been too soft on
banks.
In May, the Justice Department extracted from Swiss bank Credit
Suisse Group AG its first guilty plea from a major financial
institution in two decades, and French bank BNP Paribas SA pleaded
guilty last week to charges over its dealings with countries
sanctioned by the U.S.
It has been a tough year for Citigroup so far. In February it
disclosed an alleged accounting fraud against its Mexico unit. In
March the Federal Reserve 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.
Write to Christina Rexrode at christina.rexrode@wsj.com and
Andrew Grossman at andrew.grossman@wsj.com
Subscribe to WSJ: http://online.wsj.com?mod=djnwires