Finance

FDIC May Jump Into CDO Lawsuit

In the past couple weeks, everybody's been rushing to investigate how Wall Street banks handled the debt-backed securities called CDOs.

Now, the FDIC may wind up as the plaintiff in a CDO-related lawsuit that names ratings agencies and Wall Street firms as defendants.

The FDIC recently seized Riverside National Bank of Florida, a community bank that bought a lot of CDOs that turned toxic when the market crashed, the WSJ reports.

This particular flavor of CDO is packed with "trust preferred securities" — a financial instrument that is a combination of debt and equity.

During the boom, banks sold trust preferred securities as a way to raise capital. Wall Street firms repackaged the securities into CDOs. Then they sold the CDOs to (wait for it) community banks, among others. Community banks bought some $12 billion of trust preferred CDOs between 2000 and 2008.

Between 2005 and 2007, Riverside National Bank bought CDOs with a book value of $211 million, the WSJ says. The ratings on the CDOs got whacked during the crisis, and their value fell by 60%.

The bank sued the Wall Street firms that sold it the CDOs, as well as the agencies that rated them, arguing that there were "inflated investment-grade ratings" and "undisclosed material conflicts of interest."

Now, the FDIC is stuck with the CDOs. And it's asked the court for permission to replace Riverside as the plaintiff in the case.

The defendants include Moody's, S&P and Merrill Lynch (which is now owned by B of A).

They've argued in court documents that the Riverside's losses "result from the risks it knowingly assumed and from the unprecedented market cataclysm, rather than any flaw in the specific CDOs at issue here," the WSJ says.

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