ProPublica, who do great reporting on CDO lawsuits and have been taking the SEC’s new “if you call us repeatedly about fraud, we will eventually take your name and number and return your call within 3 to 5 business days” program seriously, today point out that there may be a little bit of miscommunication between Citi and the SEC over whether the $285 billion settlement that Citi agreed to yesterday on one $1bn CDO gets Citi off the hook for the tens of billions of other CDOs, some of which maybe don't count among Vikram's very finest moments:
A bank spokesman said the SEC would not be examining any of those deals. “This means that the SEC has completed its CDO investigation(s) of Citi,’’ the spokesman asserted in an e mail.
Whew, that's a relief. Wait:
"The $285 million settlement resolves only the Class V Funding III CDO, and we will not hesitate to bring further charges where we determine that there has been unlawful conduct," an SEC spokesman said.
Hmm. This seems like the sort of thing that you'd want to resolve before handing over the $285mm.
Actually it's hard to take that SEC spokesman's line seriously, unless someone at the SEC is really planning to sue Citi over one CDO per quarter for the rest of his or her career. More likely, they've moved on to other things, like suing all the banks that haven't been sued yet over exactly one miserable CDO apiece. ProPublica thinks this is lame, given that pretty much every Citi CDO was roughly as bad as this one, only one individual was charged, he was just a director, and everything he did was signed off by multiple layers of people above him all of whom were pretty axed to toss tons of terrible risk into CDOs and unload them on guys who were not paying all that much attention.
Which seems plausible. And if you think it's wrong to, um, do all that stuff, the SEC's behavior is puzzling. Why sue over one $1bn CDO in which, to be fair, Citi was naked short half the notional and the guy structuring the deal called it "dogshit"? Why not sue over $20++ bn of CDOs where, well, somebody was short all of the notional and probably you could find an email from someone on the structuring side saying "these buyers are tools" or "I hate this deal" or at least "the font on the offering circular is too small"?
If, on the other hand, your basic view is that sellers should disclose the facts about the assets that they're selling, but are not obligated to give open and honest disquisitions on their feelings about those assets, then this sort of makes sense. Every bank pays a symbolic settlement so that people can be good and angry, the settlement is big enough as a percentage of notional of their most ridiculous-sounding deal that it looks like a win for the SEC, and the SEC doesn't have to go to court and push a kind of novel theory of what information should be material to a structured product investor. And the bank gets to limit the attention it gets over this stuff, and avoid the small but scary possibility of a massive settlement on all its deals.
Let's test that view. Here's ProPublica on one of Citi's deals that apparently won't be getting them in trouble:
Completed in June 2007, this $3 billion deal contained a mysterious $750 million position in a CDO index. Experts believe that such positions were included for the purposes of shorting the market. Did Citi disclose why it included these assets to the investors in this CDO? As much as 30 percent of the assets in the deal were from unsold Citi CDOs. Was this a dumping ground for decaying assets the bank could not unload, as a lawsuit by Ambac, which was settled, charged?
Wait those are easy! "Did Citi disclose why it included these assets to the investors in this CDO?" Who cares? It doesn't matter why someone sold you the thing you bought, it matters what you bought. Now, it is kind of odd to buy a CDO 25% of which is an index product. But that would be odd no matter why it was included. (If anything, it's less damning than single-name assets: unlike maybe with single names, Citi has no privileged information on whether the underwriting, etc., of the things included in the index is particularly bad. If they're short the index, it's a pure macro bet.) If you're buying this thing, the thing to ask yourself is "why am I buying this CDO 25% of which is an index of CDOs?" - not "why is Citi selling it to me?"
"Was this a dumping ground for decaying assets the bank could not unload?" Yes, of course! When banks have big positions, they sell them! (Mostly.) When they have assets that they can't unload, they try harder to unload them. Possibly by lowering the price, or (as here) by throwing in less-horrible assets in a package deal. If you buy a CDO from a bank, where that bank is placement agent, and you really don't know that the bank is trying to sell it, then no amount of disclosure can help you.