In what can only be regarded as a shocking development, the United States is suing the former head of subprime mortgage trading at Deutsche Bank over “systematically and intentionally” lying about the quality of subprime mortgages that backed nearly $1.5 billion in mortgage-backed securities in the run-up to the crisis.
The lawsuit marks one of only a handful of times the government has gone after an individual for crisis-era mortgage fraud at the systemic level; an untold amount of MBS traders from this era still walk free.
According to an announcement from the Department of Justice, Paul Mangione, the former Deutsche Bank head of subprime trading, allegedly “engaged in a fraudulent scheme to misrepresent the characteristics of loans backing two residential mortgage-backed securities that Deutsche Bank sold to investors that resulted in hundreds of millions of dollars in losses.”
In its announcement, the DOJ stated that the lawsuit and the conduct Mangione allegedly engaged in are related to the DOJ’s $7.2 billion settlement with Deutsche Bank from earlier this year.
In January, the DOJ announced that it reached a settlement with Deutsche Bank in connection with the bank’s issuance and underwriting of residential mortgage-backed securities between 2005 and 2007.
While the settlement is roughly half of what the DOJ initially wanted, the settlement was still the “single largest RMBS resolution for the conduct of a single entity,” the DOJ said in January.
According to the DOJ, Deutsche Bank “knowingly made false and misleading representations to investors about the characteristics of the mortgage loans it securitized in RMBS worth billions of dollars issued by the bank” between 2006 and 2007.
And according to the new civil lawsuit filed against Mangione, he was the one who made many of those false and misleading statements about the quality of the subprime mortgages.
In its release, the DOJ stated that Mangione engaged in a “fraudulent scheme” to sell ACE 2007-HE4, a $ 1 billion subprime mortgage bond, and ACE 2007-HE5, a $400 million subprime mortgage bond, by misleading investors about the quality of the loans backing the securitizations.
The complaint alleges that Mangione also misled investors about the origination practices of Deutsche Bank’s wholly owned subsidiary, DB Home Lending, which is formerly known as Chapel Funding.
The complaint states that Chapel Funding was the primary originator of loans included in the deals in question and that Mangione approved offering documents for the mortgage bonds despite knowing that the documents misrepresented key characteristics of the loans, including compliance with lending guidelines, borrowers’ ability to pay, borrowers’ fraud and appraisal accuracy.
According to the complaint, the mortgage bond offering documents also repeatedly, falsely represented about the quality control process at DB Home, all of which was allegedly designed to mislead investors about the quality of the mortgages.
The complaint itself reads like a greatest hits of all the fraudulent conduct that took place in the run-up to the crisis, with phrases like “escalating likelihood of widespread defaults,” “nearly 50% of the loans reviewed had significant defects,” “borrowers were significantly less creditworthy than Deutsche Bank represented,” and “sky-high defect rate.”
Here’s a brief sampling of that Mangione is accused of doing:
Mangione made and approved representations about the creditworthiness of the borrowers of the mortgages securitized in HE4 and HE5 despite knowing these representations were false and that HE4 and HE5 had an escalating likelihood of widespread defaults.
Mangione had a clear understanding that Chapel Funding, LLC ("Chapel"), the primary originator of the loans in HE4 and HES, had abandoned any semblance of responsible underwriting practices-to the point of underwriting loans with confirmed borrower fraud-in order to "drive volume." Nevertheless, Mangione approved detailed representations as to the sound and responsible origination practices of the mortgage originator.
Quality control checks performed to that point reflected that nearly 50% of the loans reviewed had significant defects, including rampant guideline violations, borrower fraud, inflated appraisals and loans made to borrowers that likely did not have the ability to repay their loan.
At Mangione's direction and with his approval, the defective loans were securitized anyway. Indeed, Deutsche Bank "owned" the Chapel loans, which resided on Mangione's subprime book, regardless of the defects founds in those loans. And rather than accept the loss certain to be generated by its subsidiary's abandonment of responsible underwriting practices, or disclose to investors the defects, Deutsche Bank and Mangione surreptitiously securitized the defective loans, thereby knowingly passing the loss on to their investors. Indeed, Mangione personally selected the loans that went into HE4 and HES.
HE4 and HES proved to be disastrous failures. The relevant borrowers were significantly less creditworthy than Deutsche Bank had represented to investors, and the loans backing Deutsche Bank's RMBS ended up defaulting at exceptionally high rates and usually did so very early in their performance cycles.
Specifically, in a series of calls and email communications in mid-April 2007, the Diligence Director informed Mangione in detail of the defects found by the quality control checks, that the defective loans were nevertheless scheduled to be securitized in HE4 (and later, HES), and that the sky-high defect rate was a direct result of Chapel's intentional fraud and relinquishment of underwriting standards in an effort to do ''anything [Chapel's management] could to get volume."
The Diligence Director informed Mangione that Chapel "c[ould not] be trusted to protect the credit or regulatory or reputation or risk of the Bank." Mangione admitted he "knew all that." Mangione later stated, on separate occasions, that Deutsche Bank should "f****** fire all those guys at Chapel," and that "the guys at Chapel should be arrested for the s*** they were doing."
Nevertheless, Mangione approved the HE4 and HES offering documents, both of which touted Chapel's responsible and effective underwriting practices.
“The defendant fraudulently induced investors, including pension plans, religious organizations, financial institutions and government-sponsored entities, to name only a few, to invest nearly a billion and a half dollars in HE4 and HE5 RMBS, and caused them to suffer extraordinary losses as a result,” stated Acting U.S. Attorney Bridget Rohde for the Eastern District of New York. “We will hold accountable those who seek to deceive the investing public through fraud and misrepresentation.”
Acting Assistant Attorney General Chad Readler of the Justice Department’s Civil Division added: “The government’s complaint alleges that Mr. Mangione knew that certain of Deutsche Bank’s RMBS contained unsound mortgages that did not meet the credit or appraisal standards that the bank represented. By allegedly misleading investors about the riskiness of these securities, Mr. Mangione prioritized his and his employer’s bottom line over principles of honesty and fair dealing. The Department of Justice will continue to pursue those who engage in fraud as a way to conduct business.”
To read the government’s complaint in full, click here.
