Coverage: Citi’s $7 billion deal

The need for publicity runs both ways. A $7 billion settlement between the Justice Department and Citigroup nearly fell apart during months of negotiating, but it turns out that news of a terrorist arrest delayed a lawsuit, giving both parties another shot at reaching a deal.

The Wall Street Journal had this story by Andrew Grossman, Christina Rexrode and Dan Fitzpatrick:

A $7 billion deal between Citigroup and the Justice Department expected to be unveiled Monday nearly fell apart one day last month.

Government officials, frustrated by months of back-and-forth haggling, warned the bank that a lawsuit would be filed the next day. But hours before the deadline expired, the Justice Department put its plans on hold.

News had leaked that afternoon, June 17, that the U.S. had captured Ahmed Abu Khatallah, a key suspect in the attacks on the American consulate in Benghazi in 2012. Justice Department officials didn’t want the announcement of the suit against Citigroup—and its accompanying litany of alleged misdeeds related to mortgage-backed securities—to be overshadowed by questions about the Benghazi suspect and U.S. policy on detainees. Citigroup, which didn’t want to raise its offer again and had been preparing to be sued, never again heard the threat of a suit.

Instead, the two sides returned to the table. Were it not for that unconnected event, Citigroup and the Justice Department might not have the deal they are expected to announce tomorrow.

The New York Times reported in a story by Ben Protess, Jessica Silver-Greenberg and Michael Corkery that negotiations began with vastly different offers:

The deal caps months of heated talks that began with a $363 million offer by Citigroup followed by a $12 billion demand from the Justice Department. The reasons for such a yawning gap, the people said, were the radically divergent methods used to calculate the cost of the settlement.

Citigroup linked its initial offer to the bank’s relatively small share of the market for mortgage securities, the people said. The Justice Department, however, rejected that argument, emphasizing instead what it saw as Citigroup’s level of culpability based on emails and other evidence it had uncovered.

At one point, one of Mr. West’s deputies told the bank’s lawyers before a meeting that “there’s no way you’ll get anywhere with us if you are only going to make the market share argument.”

A behind-the-scenes account of the negotiations, based on interviews with the people briefed on the matter, who were not authorized to speak publicly, shows for the first time that the government’s bargaining position often hinges not only on a huge penalty but also on a desire to destroy Wall Street’s argument that market share should dictate punishment.

The dollars and cents of the final Citigroup settlement reflect that strategy. Citigroup had already raised its offer to $7 billion — the same size as the final settlement — when the Justice Department planned to announce the lawsuit last month.

The main breakthrough toward a settlement took a simple feat of accounting: The bank agreed to shift a portion of the settlement from state attorneys general to the Justice Department. That move, the people said, prevented Citigroup from claiming a tax deduction on the settlement. More important for the Justice Department, it meant that the bank would pay a far heftier sum than one based entirely on market share.

Karen Freifeld and Aruna Viswanatha wrote for Reuters that the amount of the settlement was a shock to some analysts:

The $7 billion has surprised stock analysts and people inside the bank, who expected Citigroup to resolve the investigations for much less.

Citigroup is the second major bank to settle with authorities since President Barack Obama ordered the formation of a task force to investigate the sale and packaging of toxic home loans, which were at the center of the 2008 financial crisis. The Justice Department issued more than a dozen subpoenas to financial institutions in early 2012.

Bank of America Corp also has been negotiating with the Justice Department over similar claims.

JPMorgan Chase & Co , the largest U.S. bank, last year agreed to pay $13 billion to settle government probes over the packaging of toxic mortgages, including by Bear Stearns and Washington Mutual, which the bank acquired during the crisis.

The $13 billion JPMorgan accord was comprised of a $2 billion penalty to the Justice Department, $4 billion in consumer relief, $4 billion to the Federal Housing Finance Agency, and $3 billion to other authorities.

Citigroup’s penalty to the Justice Department is twice what JPMorgan paid, though it had handled far fewer mortgage-backed securities, because investigators found more evidence of defective loans in the bank’s securities and more awareness of the wrongdoing at the time, the sources said.

As the Justice Department works to send the banking sector a message that it won’t allow them to get away without paying hefty fines, banks are working to avoid costly legal battles. It’s likely better for investors for banks to settle, but they are definitely paying the price for past misdeeds.