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Why the Case Against Deutsche Bank May Be An Opening Act

By Alain Sherter

Updated on: May 4, 2011 / 2:49 PM EDT / MoneyWatch

What are U.S. banks, chicken feed? That's a key question to keep in mind when thinking about why the feds chose to go after Germany's Deutsche Bank (DB) for allegedly lying about crummy mortgage-backed securities it sold to investors. It's not like Wall Street firms aren't widely suspected of similar behavior.

The answer could offer a clue regarding an even more important consideration: Does the Obama administration plan to file charges against other big banks for effectively trafficking in bad loans, or is it satisfied to smack down a single foreign financial giant as a message to its American peers? (And to the voting public, of course.)

In announcing the complaint, which focuses on U.S. government-insured loans sold by a Deutsche Bank unit, U.S. Attorney Preet Bharara hinted that other prosecutions may follow. He noted that it wouldn't be a "fantastical stretch to think we are looking at other financial institutions as well." An official with the government housing finance agency that backed the loans also said that it will ask federal prosecutors to examine other cases where banks may have engaged in fraudulent underwriting.

At least some experts think the Deutsche Bank suit is the first of many. St. John's University law prof Anthony Michael Sabino told Forbes:

"Now that the government has put Deutsche Bank under a microscope it will swing the lens around and put other lenders under a microscope, too. Typically, cases like this are followed up with more names as the prosecution goes down a line of big and small lenders. There's a lot of them out there," Sabino says.

No crime, no time
What the case is unlikely to signify, by contrast, is a sudden government commitment to punishing individual bankers for their conduct in the years leading up to the financial crisis. Bharara said specifically that there was insufficient evidence to prove that Deutsche Bank and its subsidiary, MortgageIT, did anything criminal.

Rather, the suit focuses on the narrower question of whether the financial firm committed fraud by lying to the Department of Housing and Urban Development about the quality of loans it packaged into bonds. As Bharara summarized the charges in a statement:

As alleged, MortgageIT and Deutsche Bank ignored every type of red flag and breached every duty of due diligence before underwriting thousands of federally insured mortgages. While the homes the defendants issued loans for may have been built on solid ground, the defendants' lending practices were built on quicksand. Ultimately, prudence was trumped by profit, and good faith took a back seat to good fees.

Cost of doing business?
The proposed penalty for such recklessness, while significant, is also unlikely to serve as much of a deterrent. Yves Smith notes that the type of Federal Housing Administration loans Deutsche Bank is accused of having lied about constituted only a small portion of the overall lending during the housing bubble. And she calls the $1 billion in restitution and damages prosecutors are seeking a "mere cost of doing business" compared with how much banks earned on mortgages before the bust.

Lawmakers asked Attorney General Eric Holder straight out yesterday whether Justice is investigating other banks for mortgage abuses. His answer: The agency is looking at "a variety of players in the mortgage field." But he was predictably cagier about whether the government would pursue criminal charges against any banks found to have committed the kind of misdeeds alleged in the Deutsche Bank suit. Holder said:

If there are individuals who have taken actions that would warrant individual liability, that is something that we will pursue as well.

Translation: Yes, no, maybe. Still, you've got to start somewhere. What remains to be seen is whether the government case against Deutsche Bank is a first shot in a broader campaign against big mortgage lenders or, less encouragingly, an expedient way to contain the damage.

Thumbnail from Flickr user Woodleywonderworks
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