Have lying mortgage bankers met their match?

How fitting that when Wall Street finally takes a hit after years of mortgage malpractice, the stick is called the False Claims Act.

If there is one thing that’s never in short supply in banking circles, after all, it is false claims. Internet stocks are good as gold! House prices never fall! Derivatives make the financial system safer!

A club the banks may have no choice but to join

Those particular false claims aren’t the ones that have Wall Street looking down the barrel of a $1 billion-plus government civil suit, mind you. Preet Bharara, the U.S. attorney who sued Deutsche Bank (DB) Tuesday, is going after the bank’s alleged practice of making federally insured mortgage loans without actually checking, as it repeatedly claimed, on annoying details like whether the borrowers actually had jobs or incomes or bank accounts that would allow them to repay.

In short, the feds have finally figured out a way to go after the banks for wholesale, systematic lying – a practice they have often been accused of but rarely held accountable for since the financial meltdown.

Bharara’s secret is the federal False Claims Act – a law that was originally passed in 1863 to keep suppliers from ripping off the Union Army but lately has been turned mostly on greed-ridden healthcare companies like Pfizer (PFE), Tenet (THC) and Medco (MHS) as they bilked Medicare. The government has collected $27 billion in False Claims Act recoveries since the law was strengthened two decades ago.

Bharara’s insight is that just as giant healthcare companies illicitly fattened themselves up at the Medicare trough, the banks wrongfully enriched themselves by stuffing taxpayer-backed mortgage insurers such as the Federal Housing Administration* with loans they should have known would go bad. Why, he seems to be alone in asking, should we be taking that lying down?

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Because the False Claims Act gives the government the right to sue for triple damages and to apply penalties for each instance of fraud — as many as 39,000 in this case — and because the government has been backing so much of the mortgage market, the feds at long last may have found a bit of leverage over the overleveraged crowd.

“We’re not talking about billing the government for $4,000 hammers here,” says Anthony Michael Sabino, who teaches business at St. John’s University in New York. “These allegations go to something systemic at the heart of the housing market.”

Needless to say, Deutsche takes issue with this unflattering portrait of a rampaging Teutonic Ninja lender (no income, job or assets). It points out that a lot of the bad loans were made years ago, before it owned the subsidiary that made them, and clucks that regulators had their chance then to rein in any excesses. It calls the charges “unreasonable and unfair,” and says it plans to defend itself vigorously (is there any other way?).

And it’s true enough that the government has yet to prevail in this case, let alone sue any of the other megabanks. So it’s premature to say it will send chills down the spines of the gambling with other people’s money crowd.

But the revelations of the past year, from Abacus to robosigning, made one thing clear: All the banks — from JPMorgan (JPM) and Goldman Sachs (GS) on down — have been playing the same corner-cutting game. And federal prosecutors, who have been rightly criticized for their failure to bring a single crisis-related criminal case against an executive anyone has heard of, must be eager to rattle some Wall Street cages. So it is hardly a stretch to assume similar cases are on the way.

“This is a warning shot across the bow of mortgage lenders past, present and future,” said Ed Pinto, a resident scholar at the American Enterprise Institute in Washington and a longtime student of the FHA. “It’s encouraging they’re doing this, to remind the lenders someone is watching.”

The suit alleges that Deutsche and its MortgageIT unit chased profits at taxpayer expense for a decade. They made 39,000 loans on which the government has so far paid out $386 million in insurance claims, the suit said – in addition to $888 million of mortgages that have defaulted but on which the government hasn’t had to pay out.

Because the False Claims Act calls for treble damages, plus per-occurrence penalties of as much as $11,000, Deutsche clearly faces at least $1 billion in damages and could be looking at as much as $2 billion.

There is, of course, the question of whether even a judgment of that size would discourage Wall Street from playing fast and loose next time round.

“You have two options in False Claims Act cases,” says David Feuerstein, a litigation partner at Herrick Feinstein in New York. “The fact that they took the civil option rather than the criminal one may allow you to make some assumptions about the strength of their case.”

But let’s not get ahead of ourselves. As the chart at right shows, the government has figured out how to bring in a couple billion dollars a year on False Claims Act litigation. Every little bit helps nowadays, in the age of the idiotic debt ceiling debate, and if nothing else it’s good there is a prospect of turning Wall Street upside down and giving it a good shake.

Turnabout is fair play, after all.

*Initially I mistakenly referred to the FHA as the Federal Housing Authority, leading one reader to say, in essence, Get the names right this time.

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