Series: The Wall Street Money Machine As investors left the housing market in the run-up to the meltdown, Wall Street sliced up and repackaged troubled assets based on those shaky mortgages, often buying those new packages themselves. That created fake demand, hid the banks’ real exposure, increased their bonuses — and ultimately made the mortgage crisis worse.

At a time when mortgage-backed securities were imploding and customers were fleeing the market, a junior analyst at Deutsche Bank AG protested when he was asked to alter the numbers in a spreadsheet to make a Deutsche security look less risky to ratings agencies, according to a person with knowledge of the matter.

The analyst, this person said, was asked by a mid-level Deutsche executive in late 2007 to make it appear that the investment would produce more cash than the bank actually expected at certain time points.

The request came at a crucial moment. In the last months of 2007, investors had grown skittish about such investments amid signs that the housing bubble was deflating, if not bursting. Up and down Wall Street, banks were trying to persuade ratings agencies that large portions of their mortgage-backed securities merited the coveted AAA stamp, meaning that they posed negligible risks of default. The analyst was asked to alter the spreadsheets in order to get a better rating, the person said.

The analyst's protest prompted an internal investigation conducted by a law firm, according to five current and former Deutsche employees. The protest and probe have not been previously reported.

Much remains unclear about this incident. It could not be learned whether false information was actually provided to the ratings agencies, nor whether the internal investigation dismissed or substantiated the analyst's account.

Two Deutsche employees who worked on the same team as the analyst told ProPublica they knew of no wrongdoing, and Deutsche issued a strong denial. "Any suggestion that we misled ratings agencies is unfounded and categorically false," said a Deutsche spokesman, who declined to answer specific questions about the analyst's protest or the internal inquiry.

But four years later, the revelation that an analyst protested raises questions about how vigorously, if at all, the government is investigating Deutsche Bank and its practices leading up to the financial crisis. In any case, ProPublica has learned, neither the S.E.C. nor any other government regulator or law-enforcement agency has interviewed the analyst.

The SEC's director of enforcement is Robert Khuzami. Before joining the SEC in 2009, he had been Deutsche Bank's general counsel for the Americas since 2004. He worked as one of the bank's top lawyers during the time the analyst raised questions. Khuzami has said he would recuse himself from any actions regarding Deutsche.

Another key SEC official -- George Canellos, who oversees enforcement for the New York regional office -- used to be a corporate lawyer who defended Deutsche against M&T Bank Corp. M&T, which was suing Deutsche over a security similar to the one the analyst raised objections to, had sought to depose the analyst and obtain the results of Deutsche's internal inquiry, according to people familiar with the lawsuit.

In December, M&T settled with Deutsche for $55 million in cash, M&T said Tuesday in its fourth-quarter earnings statement.

An SEC spokesman said the agency doesn't discuss whether it is investigating a firm. In general, spokesman Kevin Callahan said, Khuzami doesn't work on matters related to Deutsche, and Canellos is recused with respect to any matters related to Deutsche Bank's CDO business.

"We have policies and procedures for all staff to even prevent even the appearance of a possible conflict of interest," Callahan said. "We have experienced and professional staff ... to follow the evidence no matter where it leads, how complicated the product or which firms are involved."

The analyst's protest sheds light on a little-understood function, called modeling, that was critical to many of the transactions that wreaked major damage during the financial crisis. Modelers created vast and intricate spreadsheets that estimated or "modeled" how the securities were likely to perform, including on payment schedules.

The Analyst

Through 2006 and into 2007, a part of Deutsche Bank known as the CDO Group was humming. CDOs, or collateralized debt obligations, were securities, underpinned by mortgages, that the bank sold to investors. Even as it hawked these CDOs, Deutsche Bank and some clients were often betting that they would fail, because the mortgages that backed them looked increasingly likely to default. In essence, the bank was selling to investors a product that the bank itself believed was composed of "crap," as one Deutsche executive famously put it.

During 2006 and '07 -- when CDO sales peaked -- Deutsche ranked fourth in issuing CDOs behind Citigroup Inc., J.P. Morgan Chase & Co. and Merrill Lynch & Co., according to a 2011 report on the financial crisis issued by the U.S. Senate Permanent Subcommittee on Investigations.

Inside Deutsche's CDO Group, pressure to complete and sell the deals was intense, according to the Senate investigation, court records and people familiar with the Deutsche team. Investors were beginning to balk at purchasing CDOs because of signs the housing market was weakening. Employees often worked until 1 a.m. before being driven home in company-supplied town cars.

Among the hardest workers was a team of financial modelers and analysts. But despite their long hours, they "needed more bodies to process the work that was coming through," said a person familiar with the situation. So, some of the work was farmed out to a relatively cheap but highly skilled source of labor: Deutsche's Global Markets Centre in Mumbai, India. There, workers proficient in mathematics helped assemble and input the data for key spreadsheets.

Workers in Mumbai eagerly wanted to join Deutsche's prestigious and lucrative desks in London or New York. Few got the chance. One employee who did was Ajit Jain.

Jain had studied at the Indian Institute of Technology in New Delhi and joined Deutsche in June 2006, according to employment records kept by the Financial Industry Regulatory Authority. He joined the New York office in September 2007, when the CDO Group was struggling to find investors.

Within a short time of his arrival, according to three people familiar with the matter, Jain raised questions about whether spreadsheets were being improperly altered. His complaints went to senior levels within Deutsche, including its legal and compliance departments, according to people familiar with the matter.

A Deutsche spokesman said Jain wasn't available for comment.

Those spreadsheets were often so large and complex they could take several minutes to open on a computer, according to a person familiar with them. The spreadsheets involved fiendishly complex arrays of inputs and sophisticated calculations, involving everything from the default rates of the mortgages that backed the CDO, to when borrowers would pay off their loans. But one purpose of the spreadsheets was simple: to estimate how much cash the CDOs would generate at certain time points.

One place those estimates went was to ratings agencies such as Moody's and Standard & Poor's.

The Quest for a AAA Rating

A CDO is divided into different slices, called tranches, depending on the risk and potential return. These tranches were rated by one of the ratings agencies. For a CDO to be sold, it was crucial that the largest tranche be rated AAA, indicating that this investment was low-risk because it was the last layer to take losses.

But there was a catch: The ratings agencies relied heavily on the banks themselves to estimate the payment schedule on the underlying assets of the CDO, according to a person familiar with the work done at the ratings agencies. It was an "honors" system, this person said, in which the ratings agencies "outsourced" to the banks the inputs for the spreadsheets.

Those spreadsheets are the essence of what are known as CDO models, because the spreadsheets provide a model of how the CDO is likely to perform.

Meanwhile, banks knew how to engineer the key elements of a CDO spreadsheet so that it would spit out cash flow and other outcomes that would meet the ratings agencies' off-the-shelf formulas, according to a former ratings analyst and a former CDO manager who worked with Deutsche. In other words, banks structuring the deals knew what outcomes were necessary to receive a AAA or AA rating, and they knew how to adjust the spreadsheets to produce these outcomes, these people said.

That's the same conclusion that John Griffin came to. A professor of finance at the University of Texas at Austin, he co-authored a 2011 paper on CDO modeling that said banks pushed increasingly for top-tier AAA ratings, and that ratings agencies succumbed to the pressure. This led to a "downward movement in standards over time," Griffin said in an interview.

"Cash flow modeling is more susceptible to influence from the investment bank," the paper said.

Griffin and his co-author, Dragon Yongjun Tang of the University of Hong Kong, wrote that former employees at two investment banks told them that banks had learned how to tailor CDO models to obtain good ratings.

That is very similar to what Jain told his bosses was happening at Deutsche. According to the person familiar with the matter, a mid-level Deutsche executive asked Jain to alter the spreadsheets by changing certain payment schedules to win a higher rating.

It is not known whether Deutsche submitted such modified spreadsheets to a ratings agency to receive better ratings. As best as could be determined, the specific CDO Jain complained about was not sold to investors. It is not known why.

The Internal Investigation

According to people with knowledge of the internal probe, the alarm Jain sounded went to senior levels inside the bank, including Deutsche's compliance and legal departments.

Soon, Deutsche called in the New York law firm Milbank, Tweed, Hadley & McCloy to conduct an investigation. The law firm interviewed employees on the CDO desk, according to people familiar with the situation.

Two employees on the desk, in interviews with ProPublica, said they knew of no improper modeling, and a third said he didn't know because he wasn't part of the modeling unit.

"I personally don't think there is anything interesting," said Konstantin Kulev, who worked as a modeler on the CDO team, according to people familiar with the situation and internal Deutsche documents. In an interview with ProPublica, Kulev declined to answer specific questions.

Milen Shikov, another senior modeler, said in an interview that he knew Jain "did raise some questions" about the CDOs. But Shikov said the matter was "resolved."

Shikov recalled that he was interviewed by a law firm -- he could not remember the firm's name -- for three hours. He said he gave the law firm's questioners an email exchange with a ratings agency that he said showed Deutsche had followed the ratings agency's guidelines for preparing cash flow estimates.

A Milbank, Tweed spokeswoman declined comment. A Deutsche spokesman declined to discuss the inquiry or release the law firm's findings, but he categorically denied the bank had misled any ratings agency.

Lawsuits and a Senate Investigation

It is not known whether the SEC is investigating Deutsche. The SEC has settled with other large banks, such as Citigroup Inc. and JP Morgan Chase & Co. Critics of the agency say its settlements have been too small and have allowed the banks to neither admit nor deny wrongdoing.

Last month, M&T settled its civil suit against Deutsche, ending the high-profile case that had been wending its way through a New York state court.

M&T had alleged that Deutsche improperly sold slices of a $1.1 billion CDO called Gemstone VII that lost more than 95 percent of their value within months. M&T, according to its complaint, bought two layers of Gemstone VII: a $42 million layer rated AAA and a $40 million layer rated AA. "The AAA ratings and AA ratings were major considerations in M&T's determination to invest in the Gemstone VII notes, because they indicated that the notes were safe, stable and nearly risk-free investments," M&T claimed.

The complaint does not mention how payment schedules were modeled. But M&T contended that Deutsche and the outside Gemstone VII manager "gave false information to Standard & Poor's and Moody's, the two leading credit ratings agencies, to induce them to rate the Gemstone VII CDO notes higher than the notes deserved so as to overstate their quality and safety."

Jain's objections did not concern Gemstone VII but a later, similar CDO, according to people familiar with the matter. As part of its investigation for the suit, M&T learned of Jain's protest and the internal Deutsche inquiry, according to the person familiar with the suit, and sought to depose Jain and obtain the inquiry report.

Judge John Michalek sealed the case in April, and now M&T has settled. So the suit has revealed very little new information about Deutsche's practices.

Deutsche declined to discuss the lawsuit. In court papers, Deutsche and its law firm, Milbank, Tweed, said M&T knew the risks of investing in securities underpinned by subprime loans. A Deutsche court filing in 2008 called M&T a "sophisticated participant" in mortgage securities and that the bank had "received detailed written disclosures about the risks of the investment." The document added that M&T "was counseled to perform its own due diligence" and was told "it could not rely" on Deutsche.

At least one lawsuit concerning Deutsche's CDOs is continuing. An affiliate of Germany's IKB Deutsche Industriebank AG sued Deutsche in October after the affiliate lost money investing in five Deutsche CDOs, according to court documents from that case. The IKB affiliate alleges that by late 2005, "Deutsche knew that the subprime market had increasingly come to resemble a house of cards teetering on the verge of collapse." The court filings do not mention the modeling Jain raised questions about.

A Deutsche spokesman declined comment. One of the most detailed public accounts of Deutsche's CDO business is the 646-page, 2011 report produced by the Senate investigation. But the report does not discuss how payment schedules for Deutsche CDOs were modeled, or the internal inquiry that stemmed from Jain's alarm.

The Senate report discusses Greg Lippmann, a Deutsche risk manager who oversaw the assets in Gemstone VII and other CDOs, and helped Deutsche earn $200 million by betting against some of the bank's mortgage-backed securities. Lippmann called assets that went into the CDO a "pig" and "crap," according to the Senate report.

Deutsche's views "were fully communicated to the market through research reports, industry events, trading desk commentary and press coverage," a bank spokeswoman said. "Despite the bearish views held by some, Deutsche Bank was long the housing market and endured significant losses."

Within a few months after Jain raised the alarm, many on Deutsche's CDO team had left the bank, according to FINRA records, and now work for boutique firms that specialize in buying distressed mortgage bonds -- exactly the kind of bonds that destroyed the CDOs they once created at Deutsche.

Jain remains at Deutsche.