SEC Investigating Citi CDO "Class V Funding III"

It seems more Wall Street settlements are coming (because nobody ever goes to prison for fraud in this country). ProPublica's Jake Bernstein and Jesse Eisinger report that the SEC is investigating Citigroup's role in a $1 billion deal that the bank created in the run-up to the financial crisis. The agency is looking at whether Citi improperly pushed an independent manager to put specific assets into the deal, according to people familiar with the probe. Of course, we expect that if this is indeed the case, then Citi is currently in negotiations with the SEC to have a settlement ready in hand the second there is a formal announcement.

From ProPublica:

The deal was a collateralized debt obligation [1] named Class V Funding III, which was completed in late February 2007. The CDO was made up of pieces of other CDOs that were themselves backed by risky slices of subprime mortgages. The deal was managed by Credit Suisse Alternative Capital, a division of the Swiss banking giant. Independent managers such as Credit Suisse were charged with picking the best assets for the CDO. Citigroup arranged and marketed the deal to investors.


Details on the investigation are sparse. The SEC declined to comment on the probe. But the SEC has been conducting a wide-ranging investigation into Wall Street's CDO business, including whether investment banks created deals in order to dump assets of declining value onto unsuspecting buyers.


Among the assets purchased by Class V Funding III were portions of, or sidebets involving, at least 15 CDOs that the Illinois-based hedge fund Magnetar helped to create. Four of those CDOs were also underwritten by Citigroup. In April, ProPublica, together with Chicago Public Radio's "This American Life [3]" and NPR's "Planet Money [4]," detailed how Magnetar [5] had helped create more than $40 billion worth of CDOs as part of its strategy to bet against the housing market.

Class V Funding III was cited in another ProPublica-NPR collaboration published [2] in August. Class V bought a piece of, or had a side bet involving, two other Citi CDOs: Octonion and 888 Tactical [6]. Those CDOs in turn purchased exposure to Class V. All three CDOs closed within about two weeks of each other. Such transactions could have helped investment banks to complete CDOs and earn deal-completion fees.

Citi hedged its exposure to the Class V CDO, persuading bond insurance company Ambac to insure $500 million of it. Eight months after Class V was completed, rating agencies downgraded the deal. Earlier this month, Ambac filed for bankruptcy, largely due to its exposure to CDOs like Class V Funding III.

It's unclear whether Citi made other trades that would pay off in the event of a drop in Class V's value. Ultimately, the bank failed to protect itself against losses from most of the CDOs it invested in; Citigroup lost almost $34 billion on its mortgage CDO business.

At this point nobody seems to care. There is no risk, there is no punishment for misdeeds of any kind. That is the true new normal.




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