Federal prosecutors in Manhattan charged three former Credit Suisse traders on Wednesday with inflating the value of mortgage bonds in 2007 just as the housing market was deteriorating, a rare criminal prosecution of Wall Street executives related to the conduct during the financial crisis. The government says the men deployed the scheme to increase their year-end bonuses.
The charges, involving traders in New York and London, come just a week after President Obama pledged in his State of the Union address to escalate an effort to investigate banks and other financial firms and “help turn the page on an era of recklessness that hurt so many Americans.”
Two of the Credit Suisse traders, David Higgs and Salmaan Siddiqui, pleaded guilty to mismarking their positions to avoid losses. Both are cooperating with the government’s investigation. The third person charged, Kareem Serageldin, was their boss, who headed a group that traded mortgage-backed securities.
On a conference call on Wednesday, the United States attorney for Manhattan, Preet S. Bharara urged Mr. Serageldin, 42, an American citizen who lives in London, to come to the United States and face the charges against him.
“My client has done nothing wrong and is fully cooperating with the investigation,” said James McGuire, a lawyer for Mr. Serageldin. “In terms of how and when he plans to defend the case I need to confer with him.”
In court appearances Wednesday, Mr. Higgs, 42, and Mr. Siddiqui, 36, both said that they participated in the fraud at the direction of Mr. Serageldin.
“The stunning scale of the illegal mismarking in this case was surpassed only by the greed of the senior bankers behind the scheme,” said Robert Khuzami, the head of enforcement at the Securities and Exchange Commission, which brought a parallel civil action against the former Credit Suisse traders.
The assets that the Credit Suisse traders overvalued were mortgage-backed securities, the bonds that caused hundreds of billions of dollars in losses across the global financial system. As the housing market inflated, banks pooled mortgages, many of them to shaky borrowers, and packaged them into complex collateralized debt obligations, or C.D.O.s.
The banks then sold parts of the C.D.O.s to investors, who believed the C.D.O. structure protected them from losses on the mortgages backing the securities. Ratings agencies shared that view, often awarding C.D.O. securities a triple-A credit rating. Between 2003 and 2007, Wall Street issued nearly $700 billion in C.D.O.’s that contained mortgages, according to the Financial Crisis Inquiry Commission.
However, as the housing market crumbled in 2007, demand for mortgage-backed assets evaporated, and banks — particularly Merrill Lynch and Citigroup — were saddled with money-losing holdings that they could not sell. These would later be the source of the crippling losses that forced each to take government bailouts.
Unlike stocks, mortgage-backed securities lacked a liquid market with transparent pricing. And as the subprime-mortgage crisis escalated, it became harder for banks to attach a market value to their holdings. As their portfolios dropped in value, many banks were reluctant to mark down their holdings. These banks were later forced to take billions of dollars of losses when the housing market collapsed.
Mortgage securities were at the center of the S.E.C.’s 2010 lawsuit against Goldman Sachs that accused the bank of securities fraud, a case that Goldman paid $550 million to settle. Also in 2010, Citigroup paid a $75 million to settle S.E.C. charges that in 2007 the bank had failed to disclose some billions of dollars of subprime-mortgage exposure contained in the bank’s C.D.O.s. Neither bank admitted wrongdoing.
The government’s case against the former Credit Suisse traders depicts a brazen scheme to artificially increase the price of bonds on their books in order to create fictitious profits just as the housing market was seizing up.
In one instance, the team, facing an inquiry from Credit Suisse’s internal controls group in August 2007, tried to justify their mortgage bond portfolio’s inflated value by seeking “independent” marks from other banks’ trading desks, according to the government.
After learning that the marks at Deutsche Bank and Barclays Capital were substantially lower than their own marks, they looked elsewhere.
Mr. Siddiqui, the junior trader, subsequently secured sham “independent” marks from a friend who worked at a small investment bank.
“In less than a minute, Mr. Siddiqui’s friend generated prices on a number of AAA bonds that were nearly identical to those recorded by Mr. Siddiqui and his conspirators,” the government said.
The false profits allowed Mr. Serageldin, the head of the group, to secure a cash bonus of more than $1.7 million and a stock award of more than $5.2 million. Credit Suisse rescinded the stock award after it discovered the fraud; the government will try to forfeit the cash bonus.
The government’s investigation of Credit Suisse originated in early 2008 after the Swiss banking giant disclosed that it was taking a $2.65 billion write-down after discovering that a team of traders had mismarked the value of mortgage securities on their books.
Credit Suisse suspended the team, which was led by Mr. Serageldin. The bank, which will not be charged in the case, has been cooperating with authorities.
Mr. Bharara, whose office brought the case, has become a leading figure in the government’s effort to combat financial fraud.
The federal prosecutor appears on the cover of the new issue of Time magazine that arrives on newsstands on Friday. Plastered over Mr. Bharara’s portrait is the headline: “This Man is Busting Wall Street.”
Indeed, his office has received the most attention for its crackdown on insider trading at hedge funds, including the conviction of the billionaire Raj Rajaratnam. But the Credit Suisse prosecution is the latest in a series of fraud cases that Mr. Bharara has brought against large financial firms and their executives. In October, it brought a civil lawsuit against the Bank of New York Mellon, accusing it of cheating state and other pension funds nationwide out of foreign exchange fees over the last decade.
Earlier last year, Mr. Bharara’s office filed a civil complaint against Deutsche Bank claiming that one of its units had lied about the quality of government-backed mortgage loans it underwrote.
Both Bank of New York Mellon and Deutsche Bank have denied the government’s claims.
He has bristled at criticism — some of it from his relatives, he has said — that the government is not prosecuting enough people related to misconduct during the financial crisis. Mr. Bharara has said that complex financial fraud cases, like the four-year-old Credit Suisse investigation, take time to build and are often difficult to prove.
“The number of prosecutions is not a function of resources, effort, commitment or courage,” Mr. Bharara said last year, speaking to a group of reporters. “It is a function of the laws, the facts, and the painstaking nature of these investigations.”
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