U.S. Attorney John Walsh's Remarks At Citigroup Settlement Regarding Securities Containing Toxic Mortgages

Click here for link to Department of Justice press release and settlement documents

Press Conference on Citi Settlement
July 14, 2014, 10:00 a.m.

Remarks by John Walsh
United States Attorney for the District of Colorado

Thank you, Tony.  I am John Walsh, U.S. Attorney for the District of Colorado.  I also serve as one of the national co-chairs of the Department’s RMBS Working Group. 

The settlement announced today holds Citigroup responsible for its actions.  It holds Citigroup responsible for using false representations to sell billions of dollars of residential mortgage-backed securities full of toxic mortgage loans. 

Citigroup’s conduct had far-reaching and financially devastating consequences for investors, including investors in Colorado, the housing market and ultimately, the global economy.  Investors suffered billions of dollars in losses on the value of these RMBS securities. 

Citi knew that when it sold these securities to investors, its representations about the mortgage loans were crucial.   The mortgage loans had to have the quality and characteristics that Citi represented the loans to have.  If not, then Citi was responsible. This settlement holds Citi to its word:  The mortgage loans Citi packaged and sold to investors were not what Citi said they were.  They were far worse, and Citi knew it.   And now, Citi is being held responsible.

As U.S. Attorney Lynch will describe for you, the resolution announced today reflects the extraordinary hard work of prosecutors and staff in the U.S. Attorney’s Offices both in Brooklyn and in Colorado.   Our investigation focused on whether Citi told the truth when it securitized and sold billions of dollars mortgage loans.  Some details of what the investigation showed are set forth in a statement of facts that Citi has itself acknowledged.  Let me briefly summarize those facts, as even Citi has acknowledged them.

In the years leading up to the global financial crisis of 2008, Citi securitized numerous pools of mortgage loans from loan originators such as Ameriquest, Accredited, and New Century.  Each loan pool could contain hundreds or thousands of mortgage loans, worth billions of dollars.  Citi packaged those loan pools into securities and sold them as safe investments.

When Citi sold those securities, it provided representations to investors about the underlying mortgage loans.  Citi knew those representations were important. Investors, after all, did not have direct access to the loan files in order to make their own assessment of the loans. 

But Citi did.  It could review the loan files.  And before securitizing the loan pools, Citi did conduct a review -- due diligence -- of some loans in the loan pools. Citi hired outside underwriting firms to review a limited sample of loan files from the pool. 

Those firms checked some basic facts on the sample of loans.  The firms looked at whether the loan originator – the lender -- had followed its “underwriting guidelines,” which were criteria used to check if a borrower could pay the mortgage.  The firms checked whether the lender had followed federal, state, and local laws, laws that were designed to protect borrowers. And the firms reviewed house values and appraisals. 

Those firms gave each loan a grade.  Some loans were graded as passing.  Other loans were graded as rejects. 

The “reject” loans had material defects.  For example, a loan might be a reject if the borrower did not the ability to pay the mortgage, or if the lender violated the law when issuing the loan, or if the home appeared to be worth far less than what was being reported, or if the borrower was underwater on the mortgage.  Under its own procedures and from its representations made to investors, Citigroup knew these “reject” loans should be excluded from the securitization.

But as our investigation learned, Citi employees often personally ordered the due diligence firms to change the loan grades, from reject to acceptable.  Citi frequently ordered these grade changes without giving a reason.

And even after Citi ordered these changes in the grades, the outside firms often still reported to Citi that significant percentages of the sampled loans were rejects.  In certain instances, these “reject rates” indicated that a significant and likely comparable percentage of the unsampled loans in the pools were also “rejects.”  In other words, a small sample of the loan pools showed high reject rates, but Citi did not attempt to find those same sort of reject loans that Citi knew would be included in the rest of the loan pool, which Citi had not reviewed.

Those significant reject rates told Citi that the representations Citigroup was providing about the loans were not true.  But despite seeing these significant problems in the samples, Citi went ahead and securitized the remainder of the loan pools, and sold the resulting securities, while providing false representations about the loans. 

The statement of facts, which Citi has acknowledged today, provides a few brief examples.  Let me describe two examples. 

First, in 2007, Citi bought thousands of loans from a loan originator. The due diligence firm told Citi that large numbers of the sampled loans had material defects.  In fact, the words of a Citi trader say it all:  “[I] went thru the Diligence Reports and think that we should start praying…  I would not be surprised if half of these loans went down.  There are a lot of loans that have unreasonable incomes, values below the original appraisals (CLTV would be >100), etc.  It’s amazing that some of these loans were closed at all.”  Despite this, Citi employees then changed hundreds of loan grades from reject to acceptable.  And then Citi securitized the loans into two deals in 2007.

Second, the statement of facts also describes another series of four deals in 2007 in which Citi bought and securitized thousands of loans from a loan originator.  In early 2007, Citi explored purchasing that originator’s assets as a way to be sure that Citi’s pipeline of mortgage loans to securitize did not run dry as the residential real estate market turned down.  Citi conducted due diligence on the originator, and on the pools of loans that the originator sold to Citi.  Through its own due diligence, Citi learned that there were substantial percentages of the originator’s loans that failed to adhere to the lender’s underwriting guidelines.  Through its own due diligence, Citi learned that the originator lacked key internal quality control measures.  The problems were spelled out for Citi in the originator’s own internal audit reports.  Citi’s response to the serious issues raised about the underwriting violations and reject rates was to ignore the defects, and to purchase and securitize the loans in four securitizations in 2007.    

To its credit, in this settlement, Citi has agreed to take responsibility for its conduct, in several ways, by paying a large penalty, by providing valuable consumer relief, and by acknowledging a statement of facts that describes its conduct.  Taking responsibility for the conduct is an important step to restoring faith in the financial markets.  The strength of our markets depends on the truth of the representations that banks provide to investors and the public every day.  However, the work of the RMBS working group continues, because many other banks that have not yet accepted responsibility for their actions in selling RMBS securities full of toxic mortgages.

The strength of our financial markets depends on the truth of the representations that banks provide to investors and the public every day.  Today's $7 billion settlement is a major step toward restoring public confidence in those markets. Due to the tireless work by the Department of Justice, Citigroup is being forced to take responsibility for its home mortgage securitization misconduct in the years leading up to the Financial Crisis.  As important a step as this settlement is, however, the work of the RMBS working group is far from done, we will continue to pursue our investigations and cases vigorously because many other banks have not yet taken responsibility for their misconduct in packaging and selling RMBS securities.
I want to thank the Attorney General for his strong support of the RMBS Working Group, as well as Associate Attorney General Tony West, U.S. Attorney Lynch and the entire team from the Eastern District of New York, and FHFA-OIG for their hard work in this case.  I also particularly want to recognize Colorado Assistant U.S. Attorneys Kevin Traskos, J. Chris Larson and Lila Bateman, as well as the many other hardworking members of the team, for their outstanding work on this matter.