Gabel's Law: What Took You So Long?

A better title for this article might be “Tell Us Something We Didn’t Know.”

On May 3, the U.S. Department of Justice filed a civil suit against Deutsche Bank, accusing it of fraud in obtaining government-backed guarantees for thousands of home loans.

In 2007, Deutsche Bank bought a company called MortgageIT, and with it a portfolio that included more than 39,000 home loans. Those loans were guaranteed by the Federal Housing Administration, meaning that if the borrower (the homeowner) defaulted, the FHA would cover the loss for the lender (Deutsche Bank).

By 2009, the default rate on the loans had soared, with taxpayers eating the loss – a loss that currently amounts to nearly $400 million. But that’s not the half of the problem. Already, a third of the 39,000 loans in that Deutsche Bank package have defaulted.  Government estimates put the total expected loss at $1 billion given prolonged unemployment, inflation and rising costs (how much is gas at the pump this week?).  

While many might see this as either a good first step or even vindication, it’s important to remember that it is a civil suit. The Academy Award-winning film for best documentary, "Inside Job," drove home the point that not one criminal indictment against a big bank (or an executive of) has been sought in the wake of the financial crisis.

It is unlikely that criminal charges are a natural offspring of civil fraud suits. First, the government would have a more difficult time proving “beyond a reasonable doubt” that a bank defrauded the federal government. In a civil case, the government need only show fraud under a standard similar to “more likely than not.”   

After all, former Federal Reserve chairman, Alan Greenspan, threw himself under the bus and proclaimed that not even he – the great arbiter of economic health – could not have predicted the financial meltdown. Nonetheless, the Deutsche Bank suit could be a bellwether case that tests whether the government can successfully bring other civil fraud suits against banks.

Indeed, there are hints that the government intends to make an example out of Deutsche Bank . At the very least, banks are now on notice that officials have started the process of picking through mortgage lending practices with a fine-tooth comb.

So where did Deutsche Bank go wrong? How did it fall under the government microscope? Some might suggest that it’s politically easier to go after a foreign-born bank as opposed to the Wall Street insiders. Perhaps, but at bottom, this is a suit that underscores the lending industry’s continued practice of prioritizing profit over prudence.

Mortgages were bought, sold, packaged, and chopped like sushi in the years preceding the housing bust. More mortgages meant more mortgage-backed securities. And more securities kept investors happy.

Greed prevailed over quality controls.  A bank should know that a person who makes $40,000 year won’t be able to afford a $600,000 house. A third-grade math student could tell you that. But that simple limitation didn’t stop the banks. And hopefully they will pay for the toxic assets now left on our shoulders.