I think you are wrong on due diligence point. From what I read, Citi did the due diligence, found 45% of the loans didn’t meet underwriting standards, negotiated the price for the loans lower, but didn’t inform the buyers that 45% of the loans surveyed didn’t meet underwriting standards. The kicker in the article is that the buyers did not have access to the individual loan information. Citi didn’t give the actual loan info on each mortgage to the buyer; wasn’t available to the buyer to do the due diligence.
Think of a mutual fund as a good example. If I am a mutual fund manager and you are a prospective (or current) investor, you are basically investing money in my fund based on the expectation that I am going to make prudent, sound business decisions that you don't have the time or knowledge to make on your own. Maybe I do some research into Company X and decide that it's a terrible investment at $45 per share for any number of reasons . . . but despite all those problems it is well worth the investment risk at $15 per share. Am I obligated to disclose -- to all current and prospective investors in my fund -- the information I used to make this decision, along with the reasons why I thought it was a wise decision to buy at $15 something (shares in Company X) that I wouldn't have even dreamed of buying at $45? Absolutely not.
If an individual investor does their own research and decides that investing in Company X at $15/share was a bad idea, then they really don't have any recourse against me at all. In fact, they're just making the case that they probably shouldn't be investing in my mutual fund in the first place.
What Citi did in negotiating the prices of those "risky" loans downward is no different than what any bond fund manager does when determining what price he/she is willing to pay for different grades of corporate or government bonds. If a bond fund manager decides that a corporate bond paying 6% interest is a high default risk, then they just don't pay "face" value for that bond. It doesn't mean they don't buy the bond, it just means they discount (substantially) the amount they're willing to pay for it.