Updated, 8:21 p.m. | Talks between the Justice Department and Citigroup to settle a civil investigation into its sale of shoddy mortgage investments have deteriorated in recent days, as the sides are deadlocked on how much money the bank should pay.
The Justice Department has told Citigroup’s lawyers that it plans to sue the bank unless the sides can reach an agreement soon, people briefed on the matter said. That lawsuit could come as soon as next week, one of the people said.
The standoff sets the stage for Citigroup to be among the first large banks to fight the Justice Department’s findings in court rather than seek a settlement — a development that would carry risks for both sides.
In the settlement talks, which have dragged on since April, Citigroup has argued that it sold only a fraction of the troubled mortgage-backed securities when compared with other Wall Street banks, according to people briefed on the matter, who have asked to remain anonymous because discussions are still in flux. The bank contends that prosecutors are demanding penalties that far exceed the losses suffered by investors in the securities, these people said. The government has proposed a penalty of $10 billion, according to the people briefed on the matter. Wall Street analysts, extrapolating from a $13 billion settlement that the Justice Department reached last year with JPMorgan Chase, had estimated that Citigroup would be liable for about $2 billion.
The JPMorgan settlement was regarded on Wall Street and in Washington as a template for discussions with other large banks over investigations into questionable mortgage investments before the housing bust. Tony West, the No. 3 Justice Department official who is leading negotiations with the banks, has said the JPMorgan pact could provide a model for other agreements.
But lawyers for the big banks complain privately that federal prosecutors appeared to have scrapped that model and are demanding penalties that are far more punitive than the $13 billion paid by JPMorgan.
Similar tensions have derailed negotiations between the Justice Department and Bank of America this week, increasing the likelihood that federal prosecutors will file a lawsuit in that case as well. The harder line in recent discussions has come after the federal government had faced criticism in the past for not adequately punishing financial companies that were at the center of the problems leading to the 2008 crisis.
In its talks with prosecutors, Bank of America has argued that it is being asked to pay higher than warranted penalties for mortgage investment sold by Merrill Lynch, said people briefed on those talks. The bank has argued that it tried to back out of its acquisition of Merrill in the depths of the financial crisis, but felt pressured by regulators to go through with the deal.
Those arguments have failed to sway prosecutors, and it is unclear whether Bank of America could have legally walked away from the acquisition.
Citigroup was not nearly as large of a player in the mortgage securities market as some other Wall Street firms. In April, an analyst at Credit Suisse estimated Citigroup’s tab to settle the Justice Department investigation could total as much as $2 billion, a sliver of what prosecutors are demanding.
Still, Citigroup may have little leverage in trying to convince prosecutors that it is liable for a lesser amount. Mr. West has reminded bank lawyers that to be meaningful, settlements must have a huge penalty. When the talks began in April, the Justice Department asked for at least $10 billion, a demand the bank rebuffed, people briefed on the talks said.
By agreeing to pay large penalties, Citigroup could alienate shareholders, who will ultimately shoulder the costs of any settlement.
The banks face other risks if they go to court. If found liable in a civil lawsuit, banks could wind up paying even more than prosecutors have proposed in settlement talks. And a prolonged trial could drag out potentially damaging documents and testimony from executives, setting back the banks’ progress in regaining the trust of regulators and the public. Already, Citigroup, for instance, is embroiled in addressing other issues like a fraud scandal in Mexico and its failed Federal Reserve “stress test.”
For its part, the federal government has a mixed track record in court when trying to prove wrongdoing by banks in the lead-up to the financial crisis. Losing prominent trials against Citigroup or Bank of America could sully the Justice Department’s reputation for cracking down on mortgage misdeeds that contributed to the financial crisis of 2008.
Bank of America is one of the few banks that have already tested the Justice Department’s mettle in court.
Last October, in a case filed by federal prosecutors in Manhattan, a jury found Bank of America liable for the sale of defective mortgages issued by its Countrywide Financial unit as part of a program nicknamed the “hustle.”
The bank has had better luck defending against a lawsuit the Justice Department filed last year in North Carolina, in which prosecutors cited multiple emails from bank employees who questioned the quality of mortgages underlying the securities.
In March, a federal magistrate judge recommended tossing out the lawsuit. After holding a hearing this week on the matter, a federal judge is expected to rule soon on whether to accept the magistrate’s ruling.
The status of the Citigroup talks was first reported on Friday by Bloomberg News.
Jessica Silver-Greenberg and Ben Protess contributed reporting.