Los Angeles Wednesday filed suit in California state Superior Court against six bond insurers, alleging the companies sold what became "worthless" insurance by conspiring to promote a dual credit rating system and failing to disclose the extent of their exposure to subprime loans.
The bonds insurers took hundreds of millions in premiums for essentially "doing nothing," given municipal issuers' low default risk, according to the suit, filed in Los Angeles Superior Court.
In a second, separate suit, the city also sued a number of Wall Street banks and brokers, accusing them of rigging bids on investments such as guaranteed investment contracts.
Together, the alleged fraud cost the city millions of dollars, its attorney said.
"We're filing these suits because we believe it's time these corporations are held accountable for systematically cheating our taxpayers out of tens of millions of dollars, and doing so in clear violation of state law," Los Angeles City Attorney RockyDelgadillo said in a statement.
In one suit, the city says recent downgrades of bond insurers will cost it money because of higher interest costs. That suit named Ambac Financial Group Inc., MBIA Inc., XL Capital Assurance Ltd., ACA Financial Guaranty Corp., Financial Guaranty Insurance Co., CIFG Assurance NA, and two insurance executives as defendants.
All either declined to comment on the suit or did not reply to messages seeking comment.
The suit cites recent criticism from government officials and politicians who have said the ratings on municipal debt were systemically lower than on corporate debt with comparable default risks. Lower ratings forced issuers to either pay premiums to insurers with higher ratings or accept higher interest cost, even though the issuer was a "more trustworthy entity" than the insurer, the suit says.
Bond insurers "conspired" to support a dual rating system for corporate and municipal debt because it formed the "backbone" of their industry, leading to higher cost for issuers, the suit says. The bond insurers used their market power to pressure the ratings agencies to maintain the system, the suit says.
It does not name any of the ratings agencies as defendants. It cites recent actions by all to adjust their ratings criteria as proof the rating system was "flawed."
"This situation is not economically rational and serves as a detriment to public entities and has led to unnecessarily high borrowing costs for the public entities and unlawful profits for the insurer defendants," the suit states.
The city also accused the insurers of failing to properly disclose more than $100 billion in exposure to risky financial products, such as collateralized debt obligations of asset-backed securities. The city said the insurers entered the market for CDOs out of "greed," putting municipal clients at risk by backing billions in debt "without any dependable default rate data".
The city would not have purchased the insurance had it known of this exposure, the suit said.
"These firms assured the city of Los Angeles that the insurance they were selling would improve the city's credit rating and lower our interest rates," Delgadillo said in a statement. "Now that their own credit has been downgraded in the wake of the subprime market collapse, they'll expect us to help them offset their losses through increased premium, higher interest rates, and other costs."
In the second suit, Los Angeles accuses more than 40 financial institutions of rigging bids on financial instruments such as guaranteed investment contracts and other derivatives. Issuers typically use such instruments to invest bond proceeds they haven't spent, and the price fixing "artificially depressed" the city's rate of return, the suit says.
The lawsuit follows action taken by other municipalities. In June, a judicial panel ordered the consolidation of seven similar class-action lawsuits making similar charges. The Department of Justice, Securities and Exchange Commission, and Internal Revenue Service have also all launched investigations into alleged price fixing.
Defendants in Los Angeles' suit include: Bank of America NA; Banc of America Securities;Bear, Stearns & Co.; UBS AG; JPMorgan; Lehman Brothers; Merrill Lynch & Co.; Morgan Stanley; Piper Jaffray & Co.; Wachovia Bank, NA; Citigroup Inc.; AIG Financial Products Corp.; AIG SunAmerica Life Assurance Co.; Financial Securities Assurance Holdings, Ltd.; Financial Security Assurance Inc.; Financial Guaranty Insurance Co.; Ambac Financial Group Inc.; MBIA Inc.; Rabobank Group; Citigroup Global Markets Inc.; National Westminster Bank PLC.; GE Funding Capital Market Services, Inc.; Trinity Funding Co.; Genworth Financial Inc.; Security Capital Assurance Inc.; Natixis S.A.; SociÃ©tÃ© GÃ©nÃ©rale SA; XL Asset Funding LLC; XL Life Insurance & Annuity Co.; CDR Financial Products; Feld Winters Financial LLC; Winters & Co. Advisors LLC; Cain Brothers & Co.; Natixis Funding Corp.; George K. Baum & Co.; Kinsell Newcomb & De Dios Inc.; Sound Capital Management Inc.; Investment Management Advisory Group Inc.; First Southwest Co.; PackerKiss Securities; and Morgan Keegan & Co.