The market was waiting for the DOJ to announce the long-awaited settlement with Deutsche Bank today. Instead, it got news of a surprise lawsuit filed by the DOJ which sued Barclays after failing to settle a long-running probe into the UK bank's involvement in pre-crisis mortgage fraud. Deutsche Bank and Credit Suisse are in settlement negotiations with the DOJ over similar claims.

According to the 198-page lawsuit, the British bank deceived investors about the quality of loans underlying tens of billions of dollars of mortgage securities between 2005 and 2007 and “engaged in a fraudulent scheme to sell tens of billions of dollars of residential mortgage-backed securities (RMBS), in which it repeatedly deceived investors about the characteristics of the loans backing those trusts.’’ The suit also said that the bank “systematically and intentionally misrepresented key characteristics of the loans.”

The British bank repeatedly deceived investors about the quality of more than $31 billion in loans backing the securities that were sold between 2005 and 2007, the Justice Department said in a complaint filed Thursday in federal court in Brooklyn. More than half of the underlying loans defaulted, the government said, causing billions of dollars in losses for investors. Consultants who reviewed the loans called them “craptacular” and said they bore the “distinct aroma of default,” according to the complaint.

Barclays extended billions of dollars in financing to lenders that the bank knew were originating loans without regard to the ability of the borrowers to repay them, the government alleges. “This pump-priming activity contributed to the housing bubble and to the ensuing crash, whose effects devastated the world economy in the financial crisis of 2008,” the lawsuit alleges.

The lawsuit is rare for the big banks, which tend to negotiate a settlement rather than risk a trial, suggesting that Barclays is confident the final lawsuit terms, including protracted legal fees, would be more beneficial to the bank than to settle. As Bloomberg notes, the breakdown in talks suggests that the bank is willing to take its chances with the incoming enforcement officials in the Trump administration.

As Bloomberg also added previously, Barclays executives tried to draw the line at $2 billion in settlement charges which made an opening offer it deemed too high. The Justice Department’s starting point for negotiations wasn’t disclosed. At the same time Deutsche Bank is negotiating to lower its own settlement in a similar cash, in which the German bank is hoping to significantly reduce the amount it has to pay from the original DOJ "ask" of $14 billion.

Barclays said in a statement that the claims in the lawsuit are "disconnected from the facts" and that it has an obligation to defend against "unreasonable allegations and demands." In terms of demands, Barclays was apparently referring to negotiations with the Justice Department to settle the claims without a case being filed.

“Barclays rejects the claims made in the complaint,” the bank said in a statement, adding that it considers the allegations “disconnected from the facts.” The statement also said “we have an obligation to our shareholders, customers, clients, and employees to defend ourselves against unreasonable allegations and demands.”

As of this summer, the U.K. bank had set aside £2.5 billion ($3.1 billion) to cover fines and litigation more generally.

"Barclays will vigorously defend the complaint and seek its dismissal at the earliest opportunity," the statement said. Barclays has lined up a lawyer known for his aggressive defense of clients including Lt. Col. Oliver North.

As the WSJ adds, investors have feared that a sizable fine will eat into Barclays’s capital position. The litigation will prolong the uncertainty around the settlement and likely weigh on the bank’s share price. The British bank is currently selling down assets in Europe and Africa to try to bolster its capital position. It still faces a number of civil suits on mortgage-backed securities.

Major U.S. banks including JPMorgan and Bank of America have already paid tens of billions of dollars to settle with U.S. authorities over their pooling and sale of the securities.

According to the lawsuit against Barclays, more than half the underlying loans in $31 billion worth of mortgage loans pooled into 36 deals defaulted

The full DOJ complaint can be found here: "United States Sues Barclays Bank to Recover Civil Penalties for Fraud in the Sale of Residential Mortgage-Backed Securities"