The Department of Justice's civil fraud lawsuit against MortgageIt and Deutsche Bank seeking upwards of $2 billion struck me as newsworthy on at least two counts.
First, during the period in which Deutsche Bank's MortgageIt unit was allegedly defrauding the government and during which Deutsche Bank acquired the allegedly fraudulent mortgage unit for $430 million, a top in-house lawyer at Deutsche Bank was Robert Khuzami, who is now the director of enforcement at the SEC. Mr. Khuzami is not named in the suit or accused of any wrongdoing, but it sure will be interesting to see whether he had any role in the acquisition or in the transactions at issue.
The suit mentions that MortgageIt approved more than 39,000 mortgages for FHA insurance, totaling more than $5 billion in underlying principal. As of February 2011, more than 12,500, them, nearly a third, had defaulted. Of these, "more than 3,100 defaulted within six months, more than 4,500 defaulted within a year, and more than 6,900 defaulted within two years of closing." The federal Department of Housing and Urban Development has paid more than $386 million and owes another $888 million on these loans, a lot of the profits on the origination of which went to MortgageIt and Deutsche Bank. [The bank said the claims against it were "unreasonable and unfair," and that it would fight the suit, Bloomberg reports.]
The second point on which this struck me as newsworthy is that one of the people mentioned in the suit, Doug Naidus, who was CEO of MortgageIt and then stayed with Deutsche Bank, is someone I met with. I can't pin down the exact date — it had to have been sometime between 2001 and 2003 — but I remember going to see him in his office at the suggestion of a mutual acquaintance and coming away to remark in wonderment to a colleague at a business that was explained to me as having "no risk" because, once originated, the mortgages were immediately sold off.
The risk, it turned out, rested with the taxpayers.
For a flavor of Mr. Naidus's views at the time, it is well worth clicking through to this January 28, 2003 article from American Banker:
For a year the public has been bombarded with newspaper and magazine articles exploring the possibility that the housing boom is a bubble about to burst.
"The Next Crash," screamed a November New Yorker article. "Is Housing the Next Bubble?" Fortune magazine asked in April - and then followed with a cover story on the issue in October. "The Bubble," a Chicago Tribune headline intoned that month.
But does a real estate bubble exist? And if so, how much pain would the mortgage industry feel if it burst in whole or in part?
"The more time that goes by, the less concerned I am about a housing bubble," said Doug W. Naidus, the chief executive officer of MortgageIT, a New York mortgage bank and the largest mortgage broker in the New York metropolitan area....MortgageIT's Mr. Naidus said that the more distance the market puts between itself and the 2000-2001 recession without a major real estate meltdown, the less likely one becomes.
...Mr. Naidus, for example, said the resilience of real estate suggests that the nation's economic troubles will spare home prices.
"The so-called bubble is not growing," he said. "It's becoming either static or slightly shrinking, and that lessens the likelihood of a burst."
Also good reading — perhaps even prophetic, in retrospect — is this November 16, 2006 article from Seeking Alpha, which begins, "Deutsche Bank AG's (DB) purchase of mortgage originator MortgageIT Holdings (MHL) could be another disaster waiting to happen if Deutsche's prior record for acquisitions in the US is any guidance." The article went on:
Three aspects of MortgageIT's business are of concern: first, the downtrend in mortgage lending generally, and in particular cratering mortgage volumes in California, where 50% of MHL's mortgages are originated. Then, there is the quality of loans originated by MortgageIT: Bear Stearns is currently suing MHL to repurchase $70 million worth of loans. Finally, the Chairman and CEO Doug Naidus has been selling three quarters of his holdings near $14.60 this summer, approximately 1% below the buyout price (excluding dividends).
Oh, and one final piece of really excellent retrospective reading. Here is the CNBC transcript of Mr. Naidus being interviewed on CNBC by Larry Kudlow and Jim Cramer on September 20, 2004:
Jim Cramer, Host: This is Doug Naidus. He's Chairman and CEO of Mortgage IT, symbol MHL. Sir, congratulations on your ringing the bell. Before we get started, could you tell us whether the research reports that are out, which say you guys might have a yield as much as ten percent, are accurate?
Doug Naidus, Chairman & CEO, Mortgage IT: I think that's right. If you look at the sector, most of the active mortgage REITs are producing yields in that range for business like ours, mortgage at a self-originator, helping to do a little bit better that....Kudlow: Where do you get ten percent?
Naidus: The first thing to remember about our business is we're all residential, and we're all adjustable rate mortgages. So these are loans that have a maximum initial term of five years, three to five years, which gives us the opportunity to reset price when we get through the initial payment period and because of that, we can borrow short. So when we look at our borrowing costs, we're looking at borrowing costs inside of a three-year term, off of very high quality prime, high credit, high credit worthy borrowers. The borrowing costs are extremely low, particularly on the short end of the curve. ... Naidus:Well, what we do is we take our equity and we leverage it in a prudent fashion. We'll borrow, we'll securitize our assets, we'll borrow against them, and the market really determines our yield, not us. The yield is to our stock price. As you mentioned, our stocks traded up a couple bucks in the last sixty days, and if we continue to meet our objectives, we would expect the market to normalize us to our peers. They're presuming on a risk adjusted basis that companies like ours ought to pay nine, ten percent. That's historically, particularly in the last few years with the very wide interest rate spreads, what the guys have been able to pay...
Kudlow: You do? Boy, I'll tell you, color me stupid, but with servicing and good loans, ten percent, I think it's terrific. Anyway, Mr. Naidus, thank you very much for coming on.
I don't want to be too harsh on Mr. Naidus, MortgageIt, or Deutsche Bank, or, for that matter, on Mr. Kudlow or Mr. Cramer ("Everybody's looking for a scapegoat," as Jeff Zucker says).
For the federal government to go back to 1999 and discover that loans were improperly documented, while during the whole period presidents of both parties were issuing press releases trumpeting, and claiming credit for, the rise in the homeownership rate, and while the Fed was keeping interest rates low, is a little much. If the federal government doesn't want to deal with fraudulent loans, it should either verify the loans itself, or get out of the home loan business so that the risk is borne by the private sector rather than by taxpayers.
If we're going to review the last 12 years and make everyone give back everything they earned as a result of the housing bubble, why focus on just the banks? Are the local governments going to give back the taxes they collected on the real estate closings? Are the real estate brokers going to give back their commissions? The newspapers going to give back the money from the real estate ads? What's more, some of the loans probably wouldn't have defaulted if the government hadn't taken confidence-destroying steps that led to high unemployment. Why should Deutsche Bank have to pay because Henry Paulson was running around seizing things and turning a downturn into a panic?
Of course, the alternative — that taxpayers pay — isn't particularly attractive, either. And for Mr. Naidus, who probably made tens of millions of dollars, maybe more, personally on MortgageIt, to be running around on CNBC boasting about the "very high quality prime, high credit, high credit worthy borrowers" — at the same time that nearly a third of his FHA-insured loans are defaulting, leaving the taxpayers on the hook for more than a billion dollars — well, that's not so attractive, either. If the borrowers were so credit-worthy, why did they need federal insurance?