May 3, 2011

U.S. Sues Deutsche Bank Over

Loan Practices
By LOUISE STORY
The United States government sued Deutsche Bank on Tuesday, accusing it of
lying about the quality of home loans it handled under a government program
and demanding that the bank repay hundreds of millions of dollars of losses
on those loans.

The mortgages, guaranteed by the Federal Housing Administration, are

expected to cost the government more than $1 billion. They came from loans
issued by a company called MortgageIT, which Deutsche acquired in 2007.

The F.H.A. said it discovered the fraud in 2009, while reviewing its overall
portfolio. At the time, loans were defaulting at record levels and worries were
growing about the ultimate cost to taxpayers. Since the financial crisis, the
F.H.A. has broadened its role in the housing market and now backs about
one-third of all new mortgages, up from just 5 percent a few years ago. In the
last couple of years, the F.H.A. has also overhauled its processes to improve
quality control, and loans made more recently are performing better.

Officials from the Justice Department and the Department of Housing and

Urban Development said the lawsuit should serve as a warning to other
lenders that are issuing loans using a government guarantee. At a news
conference on Tuesday, the United States attorney for the Southern District of
New York, Preet Bharara, said Deutsche “cannot get away with lies and
recklessness.” He said there was not evidence to justify a criminal complaint
and declined to say whether there would be more cases claiming F.H.A. fraud.

In an interview, Helen R. Kanovsky, the general counsel of the Department of

Housing and Urban Development, said that Deutsche Bank was an outlier and
that most loan originators had not had such high incidences of fraud.

Responding to the government’s case, filed in Federal District Court in New

York, the bank issued a statement saying it was not involved in most of the
39,000 loans cited in the complaint. Almost 90 percent were issued before the
bank acquired MortgageIT, a real estate investment trust,the bank said. At the
time of its acquisition, MortgageIT had been operating under H.U.D.
oversight for nearly a decade, the bank said.

“We believe the claims against MortgageIT and Deutsche Bank are
unreasonable and unfair, and we intend to defend against the action
vigorously,” the bank statement said.

Of the MortgageIT loans backed by the F.H.A. from 1999 to 2009, worth $5
billion in total, about one-third have defaulted, according to the government’s
complaint against the bank. MortgageIT was not a large F.H.A. partner — it
ranked 33rd by volume at the end of 2008 — and it stopped issuing
government-backed loans in 2009.

The F.H.A. referred the problems it spotted with MortgageIT to the Justice
Department because it could not bring its own action once the company
stopped issuing loans. The case was pursued by a civil fraud unit that Mr.
Bharara set up about a year ago.

The complaint against Deutsche Bank stands out because the government has
filed relatively few cases against big banks related to the financial crisis. Its
actions have mainly been civil complaints, as was the one against Deutsche
Bank. The government has found it difficult to prove intent to defraud, a
requirement for a criminal case, and investigators got off to a slow start in
building possible cases during the crisis becauseregulators were primarily
focused on stabilizing the system. The Justice Department has generally had
more success prosecuting small mortgage brokers and borrowers for mortgage
fraud than it has had in pursuing major financial institutions.

The Deutsche suit does not name any individual bank employees. And it is not
centered on the subprime loans that kicked off the housing collapse.

Deutsche was, however, a large player in the subprime market, and mortgage
bonds created by the bank sit in many investors’ portfolios. Its mortgage
bundling behavior was outlined in a recent report issued by the Senate’s
Permanent Subcommittee on Investigations.
The Deutsche loans that were backed by the F.H.A. jumped out during the
portfoliowide review of mortgages, said Ms. Kanovsky. “The real harm to us
was clear,” she said.

MortgageIT had been warned by the F.H.A. for years, Ms. Kanovsky said, long
before Deutsche bought it. Workers there frequently told the government that
they were taking care of the problems, “all of which turned out to be not true.”

The problems at MortgageIT are rooted in the same sort of behavior that
plagued the overall lending market — bankers did not take enough care to
ensure the quality of their mortgages because they could resell the loans to
private investors. Deutsche, the complaint said, had “powerful financial
incentives to invest resources into generating as many F.H.A.-insured
mortgages as quickly as possible for resale to investors.”

MortgageIT was qualified by H.U.D. to issue mortgages guaranteed by the

F.H.A. MortgageIT and Deutsche filed annual certifications that the loans they
issued complied with H.U.D. rules. The complaint says the bank had a
fiduciary duty to make correct representations to the government.

Yet, the complaint says, Deutsche “repeatedly lied to H.U.D. to obtain and
maintain MortgageIT’s direct endorsement lender status.” In particular, the
complaint said Deutsche did not monitor how often home owners defaulted
on their mortgages immediately after receiving the loans.

Trouble was apparent at MortgageIT as early as 2003, according to the

complaint. When a HUD audit revealed that the company had not met quality
control levels, the company assured the government that it had altered its
practices to comply. But it had not, the complaint says. There were several
other instances where the company made similar false statements about its
quality control unit, which was chronically understaffed, the complaint says.

MortgageIT, based in New York even before the Deutsche acquisition, once
had over 2,000 employees, mortgage loan offices across the country and
licenses to issue loans in all 50 states.