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Justice Department Bolsters Mortgage Suit Against Deutsche Bank

Source: WSJ – Jessica Holzer

Posted on 25 Aug 2011

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The Justice Department moved to bolster its accusations that Deutsche Bank AG officials knowingly lied about the quality of mortgages made by a unit of the bank that were guaranteed by the government.

Prosecutors, in an amended complaint filed in federal court in Manhattan on Monday, added fresh details about due diligence performed by Deutsche Bank officials before purchasing MortgageIT Inc. in 2007 that allegedly would have revealed control breakdowns at the mortgage lender.

The government also described the tight integration of the mortgage unit into the bank, in an attempt to show Deutsche Bank officials knew or should have known that representations made to the government about the quality of MortgageIT loans were false.

The amended complaint expands the lawsuit to include two additional Deutsche Bank units, DB Structured Products Inc. and Deutsche Bank Securities Inc.

Deutsche Bank in July asked a federal judge to throw out the suit, which seeks to recover alleged damages and losses on mortgages insured by the Department of Housing and Urban Development.

In a statement Tuesday, Deutsche Bank called the amended lawsuit unfounded. "We do not believe the deficiencies in the government's original complaint have been cured by this amended complaint and we will continue to defend ourselves vigorously," a spokesman for Germany's largest bank said.

Between 1999 and 2009, MortgageIT was a "direct endorsement lender," allowing it to approve Federal Housing Administration insurance for more than 39,000 mortgages worth a total of more than $5 billion, according to the suit. More than 12,500 of those mortgages have gone bad, some as quickly as two months after the loans were made.

As a result, HUD had paid out $386 million as of February in insurance claims based on loans underwritten by MortgageIT, according to the U.S. government. The agency is on the hook for an additional $888 million on loans that have defaulted but where claims haven't yet been paid.

During the housing boom, the German bank and other Wall Street firms bought lenders in order to feed their mortgage operations. Loans were pooled into mortgage bonds and sold to investors, a lucrative business at the time, but one that helped fuel the financial crisis and has come back to haunt the firms.

Deutsche Bank allegedly conducted substantial due diligence on MortgageIT before the merger in 2007 that gave it access to evidence the mortgage lender had violated HUD rules and made false statements to the government, but the bank allowed the misconduct to continue, the Justice Department said.

For example, prosecutors said the bank allegedly had access to a June 2005 letter in which a senior MortgageIT manager acknowledged to HUD that the lender hadn't been reviewing all government-insured loans that defaulted quickly after being closed and falsely said that the lender would do so in the future.

The amended lawsuit seeks to portray Deutsche Bank's close oversight of the mortgage lender after the merger. It describes how Deutsche Bank retained the lender's management and work force but integrated the lender into its risk-control structure "such that Deutsche Bank was cognizant of, involved in, and ultimately responsible for MortgageIT's activities."

Deutsche Bank also set up a committee of seven senior managers from MortgageIT and five from Deutsche Bank to oversee the lender's credit risk, Justice said. Meanwhile, senior Deutsche Bank officials, Patrick McEnerney and Joseph Swartz, signed annual certifications in 2007 and 2009 vouching that MortgageIT's operations met HUD's standards for direct endorsement lenders.