February 21, 2013

Banks Were Also Victims of Toxic Debt and Overrated CDOs, Contends US DOJ

It wasn't just investors that suffered during the toxic debt crisis. According to the United States Department of Justice, Bank of America Corp. (BAC), Citigroup (C), and other financial institutions that created and bought collateralized debt obligations also lost big after a lot of these investments failed within a year after they were sold even though they received high credit ratings. These claims are reflected in the DOJ's recently filed securities case against Standard and Poor's and its parent company McGraw-Hill Cos.

In this lawsuit, the government is invoking The Financial Institutions Reform, Recovery, and Enforcement Act of 1989. While the DOJ believes that CDO underwriters exerted enough pressure to compel the credit rating agency to lower its standards and delay ratings method changes that would have made it harder to give out the highest rankings, prosecutors are still seeking to hold S & P accountable.

The AAA mortgage ratings that were issued is a main reason that financial firm executives disregarded the possible dangers that came with these investments, many of which consisted of bundled CDOs, including mortgage-backed bonds and derivatives that were then divided into new securities that came with different degrees of risk. These highly rated mortgage securities really took off in 2007, but when related losses happened the following year, they were huge.

According to prosecutors, credit rating agencies such as S & P failed to modify its analytical models and take the actions needed to make sure the risk involved with each security was accurately reflected. The lawsuit questions whether the company clearly portrayed the degree of care it exercised when issuing credit grades and avoiding conflict more than the actual accuracy of the ratings. Internal documents and emails reportedly reveal that financial executives worried that implementing stringent standards would compel issuers to go to another credit rater for the job.

Listed as one of the bank victims is Citigroup (C), which underwrote several of the 12 CDOs that the government names in its securities case. Citigroup would go on to require a federal rescue of $45 billion, which imperiled taxpayer money. Another alleged bank victim is Bank of America (BAC), which retained S & P to grade two of three CDOs, including one supervised by hedge fund manager Ralph Cioffi of Bear Stearns (now owned by JP Morgan Chase & CO (JPM)). Others on the DOJ's victim list include credit unions WesCorp., Eastern Financial Florida Credit Union, certain M & T Bank units, and First Midwest Bancorp. Credit unions are now paying special assessments over losses on failures. This could lead to lower savings rates for consumers.

If you are a financial institution that suffered CDO losses because credit rating agencies overrated your investments, please contact our securities fraud lawyers today.