Feds take billion-dollar whack at Deutsche Bank

May 3, 2011, 8:19 PM UTC

The Justice Department wants to take a billion-dollar chunk out of the Wall Street mortgage-kiting machine.

The U.S. attorney for Manhattan sued Deutsche Bank (DB) Tuesday, claiming its MortgageIT unit made tens of thousands of bad loans and then duped the Federal Housing Authority into insuring them. The scheme left taxpayers holding the bag to the tune of hundreds of millions of dollars, the government said.

Feds fed up

The government’s civil suit was provoked by “years of reckless lending practices,” Preet Bharara, the U.S. attorney for the Southern District of New York, said in a statement.

The suit says Deutsche and MortgageIT made bad loans, failed to audit their processes as required and “repeatedly lied” to continue participating in a program that made FHA insurance readily available to lenders.

Deutsche didn’t immediately return a call seeking comment. Its shares fell 1% in midday trading.

The government said it will seek treble damages and penalties under the False Claims Act. That act is typically invoked in whistleblower suits but is being used in this case to allege the company ripped off the Treasury by funding loans it knew would go bad.

The FHA has paid $386 million in claims and related costs on loans Deutsche made between 1999 and 2009, the suit says, and expects to pay out “hundreds of millions of dollars in additional FHA insurance claims” in coming years as more loans default. Based just on the amounts the FHA has paid so far, Deutsche could end up on the hook for $1.16 billion in claims.

But that number could rise, based on the hundreds of millions of dollars in claims they expect FHA to pay out in coming years and on an additional possible penalty assessment.

The government’s suit says Deutsche’s MortgageIT endorsed more than 39,000 mortgages for FHA insurance over a decade – many of which went bad early, in what is widely taken as a sign of likely fraud.

The suit says the department of Housing and Urban Development, which runs the FHA, has paid out $386 million through February on 3,100 defaulted mortgages. Of those, more than 600 defaulted within six months, 1,100 defaulted within a year and more than 2,000 – nearly two-thirds of the total – went bad within two years.

The suit says some $888 million of mortgages were in default without claims having been paid by HUD. Some $348 million of those mortgages went bad within a year and more than half went bad within two years, it said.

The suit comes at a time when the public is exasperated about the government’s failure to bring any major Wall Street players to justice in the mortgage fiasco, which saw the big banks and their top employees reap huge windfalls by making loans that later went bad, resulting in foreclosure for homeowners and a massive bill for the public. A nice deal if you can get it.

It’s not that the government has been completely asleep at the wheel. Lee  Farkas, who ran a top mortgage wholesaler, was convicted last month in what prosecutors called a “significant victory” in the battle against mortgage fraud. The feds have picked up some smaller fish along the way too.

The case against Deutsche is another major step. But the sad moral of the past decade is that the mere threat of paying out shareholder money is not punishment enough to make Wall Street clean up its act. So even a billion-dollar lawsuit, as good a thing as that might be, ends up feeling a day late and a dollar short.

Also on Fortune.com:

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