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Banking

Deutsche Bank wages legal fight in the US

Three years ago, the real estate bubble burst in the United States. While the search for those to blame continues, Deutsche Bank is being targeted by prosecutors - but may escape the worst.

Alongside the big US banks, Deutsche Bank is one of the major players in the American real estate market. Germany's largest bank holds around a million houses in trust, many of which have now been foreclosed.

As a result of the subprime mortgage crisis, there are now entire suburbs dotted with homes that are standing empty and falling into ruin. The affected communities have been putting up resistance and are attempting to bring the banks responsible to justice.

"Pension funds and unions that had made investments have been filing lawsuits in many places," Lawrence White, a professor of finance at New York University, said. Prosecutors across the country are also investigating Deutsche Bank's business activities. "This process is taking a very long time, and even if no new cases were to be added, there have yet to be settlements for cases reaching back two or three years," White said.

Under fire from the SEC

Deutsche Bank is now also facing closer scrutiny from the US Securities and Exchange Commission (SEC). That's because the bank is believed to have knowingly sold securities packages that were bundles of junk mortgages to unsuspecting investors. Some two years ago, similar dealings cost the investment bank Goldman Sachs $550 million (415 million euros) in out-of-court settlements.

Goldman Sachs had created a product called "Abacus" in which mortgage securities were pooled. What investors didn't know: "A third party – hedge fund manager John Paulson – helped pick out the securities in order to bet against them," White explained.

Rumors have it Deutsche Bank is suspected of involvement in similar practices, but the SEC has not yet commented officially. "The SEC was able to get $550 million for the Abacus deal, but Deutsche Bank had an almost identical product on the market called Start," said Yves Smith, a banking expert with the financial consulting group Aurora Advisors in New York and author of the finance blog called "Naked Capitalism."

Unbiased SEC?

Smith says he doesn't understand at all why SEC investigators didn't target Deutsche Bank much earlier. Emails from Goldman Sachs proved the bankers knew about the poor quality of their product. At Deutsche Bank, the now notorious trader Greg Lippman was responsible, among other things, for these investment banking products – "and Lippman was considered a chatterbox in the industry," Smith said. Chances are high that he said incriminating things about Deutsche Bank in emails or discussions, Smith added.

"If they were able to catch Goldman Sachs, they can also catch Deutsche Bank, if they want to," Smith said. But she says it's no mystery why the German bank has been let off the hook so far. German newspapers claimed the bank was more careful than its American competitors, but this is nonsense, according to Smith.

"It's Robert Khuzami who made the difference," Smith said. DB is lucky that the SEC's top investigator headed Deutsche Bank's legal department in the crucial years between 2004 and 2009. "Otherwise, as a foreign bank, Deutsche Bank would probably be the first in line."

But even an out-of-court settlement involving a payment of $500 million wouldn't ruin Deutsche Bank – as it didn't ruin Goldman Sachs. And higher fines are very rare with the SEC. Smith says investigators there don't have the resources and stamina to deal with the cases properly and are generally not very well positioned to cope with such unwieldy cases.

"The cases are too complex, and explaining to the jury how mortgage papers work is very time-consuming," said Lawrence White. And the longer a probe lasts, the smaller the SEC's chances of winning a case.

More plaintiffs

In the spring of 2011, the US administration also filed a lawsuit against Deutsche Bank, claiming that DB's Mortgage IT subsidiary made false statements about the quality of mortgages and was wrongly included in a state funding program as a result. That trial, too, is far from over. Other lawsuits came from some of the unhappy investors such as the Dexia finance group and Loreley Financing, a special-purpose entity of the German Industry Bank (IKB).

But what could really rock Deutsche Bank's boat could be lawsuits from any of the big hedge funds such as Blackrock or the Man Group. But according to Yves Smith, those funds don't have any big incentives to step into action, and they themselves would have to pay for any litigation while other players would just look on and profit from the lawsuit.

Smith says the dealings on Wall Street are sometimes worse than those of the Mafia. All the players are afraid of the big banks, she argues, as many fear they could be cut off from vital financial flows for their businesses.

Too big to fail?

If nothing else, Deutsche Bank profits from not having been an executive service agency, because as such it was not involved in real estate debt collecting or foreclosures. It has almost exclusively acted as a trustee.

Meanwhile, experts agree that trustees too didn't get everything right and that they could indeed be sued. "But nobody's doing that," says Yves Smith. This is because in each case a huge number of mortgage certificates would be affected.

And if these were all to fail at once, says Smith, it could trigger another tsunami of the magnitude of the Lehman Brothers bankruptcy. Paradoxically, the trustees appear to be too big to fail – and too big to fall.

Author: Miriam Braun/ hg
Editor: Simon Bone