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Mortgage mess sinks development bank portfolio

WASHINGTON — The Inter-American Development Bank, the largest lender for projects including roads and power plants in Latin America, lost $1.9 billion on mortgages and other securities as part of an unusually aggressive investment strategy, according to internal bank documents obtained by The Associated Press.

The bank is funded by donations from wealthy countries such as the United States. It downplayed the losses even as an independent auditor blamed bank managers and called for a review of the investment strategy.

A decade ago, the bank kept its money almost exclusively in government bonds and bank accounts. By 2006, investments in asset-backed securities such as mortgages, credit card debt and home equity credit lines represented 60 percent of the bank's portfolio, according to the audit.

Auditors determined the bank got in over its head.

"The bank's risk management lacks the specialized systems and skills to adequately assess the risks in the current, relatively complex, portfolio," according to the report, which was submitted to the bank in December. The report was prepared by a panel of outside experts, including Anthony Santomero, the former president of the Federal Reserve Bank of Philadelphia.

The bank's chief financial officer, Edward Bartholomew, would not discuss the report. He acknowledged the bank booked a loss of $1.6 billion "on paper" in 2008 from investments that have fallen in value. But he said they are worth more than what they can be sold for during the current financial crisis.

Development banks maintain investment portfolios only to store the money they will later lend, ensuring it is available when needed. If the Inter-American Development Bank needed the money from depressed assets quickly, it would have to sell them and lock in the huge losses.

However, Bartholomew said the bank has plenty of cash so it can afford to wait to see whether the investments recover as he expects.

Bartholomew defended the bank's decision to invest so heavily in asset-backed securities, saying the plan was to make its returns less volatile, not to make more money. Auditors found the concentration of such investments in the bank's portfolio was twice as high as at the World Bank and almost 10 times as high as at the Asian Development Bank.

"The strategy was driven by the board-approved strategy of minimizing credit risk and not to take any interest-rate risk," Bartholomew said.

The bank invested only in asset-backed securities that got top scores from credit rating agencies. The audit found that the bank relied too heavily on such ratings and unintentionally created a portfolio highly exposed to big losses.

Auditors said the bank might want to hire outside investment managers if it intends to keep such a complicated portfolio.

Bartholomew disagreed.

"I don't think there's any question about the ability of the team here to manage this portfolio," he said.

He said the bank would review its investment strategy but said its fundamentals were sound.

Congress, which likely will be asked this year to approve more money for the bank, has questions. Sen. Richard Lugar, R-Ind., challenged the bank's Colombian president, Luis Alberto Moreno, to explain what went wrong.

"The reported scale of the IDB's investment portfolio losses of $1.9 billion — 10 to 100 times higher than the losses of the other development banks — is of grave concern," Lugar wrote in a letter last week.

Batholomew sought to ease those concerns. He said discussions about whether to commit more money to the bank should be separate from discussions about its investment woes.


Associated Press writer Toby Sterling contributed to this report from Amsterdam, Netherlands.