Citigroup will pay $7 billion to settle the U.S. government's accusations that it misled investors about the quality of mortgage securities it sold in the run-up to the financial crisis. Saabira Chaudhuri joins MoneyBeat. Photo: Getty Images.
WASHINGTON—As the seeds of the financial crisis were being sown, a Citigroup Inc.C +3.02% trader sent an internal email warning about the poor quality of mortgages the bank was packaging into securities and selling to investors.
"We should start praying," the trader wrote in the email.
On Monday, the bank agreed to pay $7 billion, including a $4 billion civil penalty to the Justice Department, $500 million to the Federal Deposit Insurance Corp. and several states, and $2.5 billion earmarked for "consumer relief," to settle the U.S. government's allegations it knowingly sold shoddy mortgages ahead of the crisis.
The settlement doesn't absolve Citigroup or its employees from facing any possible criminal charges, Attorney General Eric Holder said. He declined to say whether the government was pursuing criminal charges.
Citigroup, in a statement of facts, admitted to repeatedly brushing aside warnings from both inside and outside the bank that many of the loans it had packaged had serious problems and concealing that information from investors.
Attorney General Eric Holder announces that Citigroup will pay $7 billion in a settlement with the U.S. Justice Department for misdeeds in 2008. Photo: Getty
Mr. Holder said the bank sold mortgage-backed securities with widespread defects and described Citigroup's conduct as "egregious."
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According to the U.S. Justice Department, Citigroup knowingly sold mortgage-backed securities with loans that contained "material defects." Associated Press

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"The bank's activities contributed mightily to the financial crisis that devastated our economy in 2008," Mr. Holder said. "Taken together, we believe the size and scope of this resolution goes beyond what could be considered the mere cost of doing business."
The Justice Department said that when a third-party "due diligence vendor" turned up a significant portion of mortgages that were found to be low-grade, such as missing key documents or made to borrowers with poor credit, the bank often chose not to reject the loans. Instead, Citigroup engaged in a sleight of hand, in which it reclassified the loans as better-performing, the Justice Department said, and then misrepresented their quality to investors.
"Citigroup employees often personally ordered the due diligence firms to change the loan grades…from reject to accepted," said U.S. Attorney John Walsh of Colorado, whose office helped lead the investigation.
Such conduct helped fuel the Justice Department's push for a hefty fine over the objections of Citigroup, which had argued that it shouldn't have to pay so much because it was a relatively small player in the mortgage-securities market.
In all, the Justice Department uncovered 45 mortgage-security deals in 2006 and 2007 in which the bank made misrepresentations about the quality of the underlying loans, said Loretta Lynch, the U.S. attorney from Brooklyn.
"We believe that this settlement is in the best interests of our shareholders, and allows us to move forward and to focus on the future, not the past," said Citigroup Chief Executive Officer Michael Corbat.
The Citigroup penalty is the latest enforcement action stemming from the Justice Department's probe of banks' precrisis sales of residential mortgage-backed securities.
Bank of America Corp. BAC +1.24% is in discussions to pay at least $12 billion to settle similar civil charges by the Justice Department and some states, though the bank and the government remain billions of dollars apart, according to people familiar with the talks. The bank is offering $12 billion, according to the people. The bank has already paid $6 billion to settle separate allegations about its mortgage-backed securities by the Federal Housing Finance Agency. J.P. Morgan Chase JPM +0.88% & Co. settled similar allegations for $13 billion last year.
The Justice Department has also extracted large penalties for nonmortgage-related conduct, including an $8.9 billion settlement from BNP Paribas SA BNP.FR +0.86% over the French bank's efforts to circumvent U.S. sanctions on various countries and a $2.6 billion penalty levied on Credit Suisse Group AG CS +2.46% related to its effort to help Americans evade taxes. BNP and Credit Suisse pleaded guilty to criminal charges. J.P. Morgan agreed to a statement of facts that it had knowingly misled investors. Bank of America has neither admitted nor denied the allegations.
The government's description of wrongdoing at Citigroup closely mirrors conduct outlined in the Justice Department's settlement with J.P. Morgan. In both cases, the banks acknowledged repeatedly giving investors misleading information about mortgages underlying the securities. In many cases, those mortgages didn't meet internal underwriting guidelines but were included in packages and sold to investors.
Citigroup bought some of its loan pools from other companies, including Countrywide Financial Corp., which was later bought by Bank of America, and New Century Financial, a subprime lender that later went bankrupt.
In a conference call with reporters, Citigroup Chief Financial Officer John Gerspach declined to comment on whether the bank had asked for release from any potential criminal charges as part of the settlement.
Citigroup's penalty, unlike J.P. Morgan's, releases it from potential liability to the Justice Department for collateralized debt obligations, or CDOs, not just mortgage securities. The settlement covers residential mortgage-backed securities and CDOs issued in the run-up to the financial crisis, from 2003 to 2008. Citigroup was a major player in CDOs, which are pools of mortgages and other debts that are packaged and sold to investors.
Separately, the bank faces a continuing probe of whether its Banamex unit in Mexico did enough to stop suspected money laundering in suspicious transactions along the U.S.-Mexico border. Also, in February, it disclosed an alleged accounting fraud in its Mexico unit.
Meanwhile, Citigroup said second-quarter profit plunged 96% as the bank took a $3.8 billion charge tied to the settlement. On Monday, shares of the bank ended 3% higher, at $48.42, as results beat analyst estimates. The bank's shares are down 7.1% this year.
In addition to Citigroup's problems with Banamex, the Federal Reserve in March rejected its stress-test request for a higher dividend and share buyback, citing a need for the bank to improve its overall risk-management systems.
Citigroup's $7 billion agreement comes after a long negotiation. The bank in May had opened with an offer to pay $363 million in cash, plus more for consumer relief. The Justice Department came back with a far higher number: close to $12 billion, including consumer relief.
The negotiations were seen as a flash point for both Mr. Corbat, who was given the top job in 2012 with a mandate to improve relations with the government, and for Mr. Holder, who has faced criticism from Congress that the Justice Department has been too soft on banks.
Write to Christina Rexrode at christina.rexrode@wsj.com and Andrew Grossman atandrew.grossman@wsj.com