Inquiry Focuses on Withholding of Data on Loans

Correction Appended

An investigation into the mortgage crisis by New York State prosecutors is now focusing on whether Wall Street banks withheld crucial information about the risks posed by investments linked to subprime loans.

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In Queens, an advertisement for a company offering refinancing or credit services to those in danger of foreclosure. The state and others are studying the role of Wall Street banks in enabling the mortgage boom that led to a sharp rise in defaults and foreclosures.

Reports commissioned by the banks raised red flags about high-risk loans known as exceptions, which failed to meet even the lax credit standards of subprime mortgage companies and the Wall Street firms. But the banks did not disclose the details of these reports to credit-rating agencies or investors.

The inquiry, which was opened last summer by New York’s attorney general, Andrew M. Cuomo, centers on how the banks bundled billions of dollars of exception loans and other subprime debt into complex mortgage investments, according to people with knowledge of the matter. Charges could be filed in coming weeks.

In an interview Thursday, Connecticut’s attorney general, Richard Blumenthal, said his office was conducting a similar review and was cooperating with New York prosecutors. The Securities and Exchange Commission is also investigating.

The inquiries highlight Wall Street’s leading role in igniting the mortgage boom that has imploded with a burst of defaults and foreclosures. The crisis is sending shock waves through the financial world, and several big banks are expected to disclose additional losses on mortgage-related investments when they report earnings next week.

As plunging home prices prompt talk of a recession, state prosecutors have zeroed in on the way investment banks handled exception loans. In recent years, lenders, with Wall Street’s blessing, routinely waived their own credit guidelines, and the exceptions often became the rule.

It is unclear how much of the trillion subprime mortgage market is composed of exception loans. Some industry officials say such loans made up a quarter to a half of the portfolios they saw. In some cases, the loans accounted for as much as 80 percent. While exception loans are more likely to default than ordinary subprime loans, it is difficult to know how many of these loans have soured because banks disclose little information about them, officials say.

Wall Street banks bought many of the exception loans from subprime lenders, mixed them with other mortgages and pooled the resulting debt into securities for sale to investors around the world.

The banks also did not disclose how many exception loans were backing the securities they sold. In prospectuses filed with regulators, underwriters, in boilerplate legal language, typically said the exceptions accounted for a “significant” or “substantial” portion. Under securities laws, banks must disclose all material facts about the securities they underwrite.

“Was there material information that should have been disclosed to investors and/or ratings agencies which was not? That is a legal issue,” said Howard Glaser, a consultant based in Washington who worked for Mr. Cuomo when he was secretary of the Department of Housing and Urban Development in the Clinton administration.

Mr. Blumenthal said the disclosures offered by banks in their securities filings appeared to be “overbroad, useless reminders of risks.”

“They can’t be disregarded as a potential defense,” Mr. Blumenthal said. “But a company that knows in effect that the disclosure is deceptive or misleading can’t be shielded from accountability under many circumstances.”

Under Connecticut law, Mr. Blumenthal could bring only civil charges in his inquiry. In New York The Martin Act in New York gives the attorney general broad powers to bring securities cases, and Mr. Cuomo could bring criminal as well as civil charges.

Mr. Cuomo, who declined to comment through a spokesman, subpoenaed several Wall Street banks last summer, including Lehman Brothers and Deutsche Bank, which are big underwriters of mortgage securities; the three major credit-rating companies: Moody’s Investors Service, Standard & Poor’s and Fitch Ratings; and a number of mortgage consultants, known as due diligence firms, which vetted the loans, among them Clayton Holdings in Connecticut and the Bohan Group, based in San Francisco. Mr. Blumenthal said his office issued up to 30 subpoenas in its investigation, which began in late August.

Officials at Wall Street banks and the American Securitization Forum, which represents industry, declined to comment, as did the due diligence firms. Credit-rating firms would not say if they had been subpoenaed but said that they were generally not provided due diligence reports, even when they asked for them.

The S.E.C. is also examining how Wall Street banks sold complex mortgage investments. The commission has about three dozen active investigations in the area, said Walter G. Ricciardi, the deputy director of enforcement. “We have not yet concluded whether the securities laws were broken,” he said.

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Correction: January 16, 2008

A picture caption with the continuation of a front-page article on Saturday about an investigation by the New York attorney general related to subprime loans referred incorrectly to a sign in a photograph of a residential street in Queens. The sign was an advertisement for a company offering refinancing or credit services to those in danger of foreclosure. It was not a foreclosure sign.