Deutsche Bank and its subsidiary MortgageIT "repeatedly lied to be included in a government program to select mortgages for insurance by the government," the Justice Department complaint said.
"While Deutsche Bank and MortgageIT profited from the resale of these government-insured mortgages, thousands of American homeowners have faced default and eviction, and the government has paid hundreds of millions of dollars in insurance claims, with hundreds of millions of dollars more expected in the future," it said.
The suit, filed Tuesday in New York federal district court, said that MortgageIT, acquired by Deutsche Bank in January 2007, insured 39,000 home loans worth more than $5 billion with the Federal Housing Administration (FHA) in the decade to 2009.
The mortgages were "recklessly" approved by the company in "blatant disregard" of whether the borrowers would be able to make payments on them.
Both the bank and MortgageIT "made substantial profits through (the) resale of these FHA-insured mortgages," many of which later ended up in default, the complaint said. Despite the mortgages' low quality, MortgageIT falsely claimed it had performed due diligence and asserted them as eligible for FHA insurance.
It also failed to monitor defaults as required, the suit alleged.
"MortgageIT took the only staff member dedicated to auditing FHA-insured mortgages and reassigned him to production instead," it said.
The company also "literally stuffed" into a closet unopened, unread outside auditor reports on the problem, it said.
Deutsche Bank's and MortgageIT's mortgage operations were in "egregious violations" of FHA requirements.
The result was that, not long after being sold on to investors by Deutsche Bank and its subsidiary, thousands of the loans went into default, costing the insurer while the bank profited.
The government said it had paid out $386 million as of February this year for claims on 3,100 home loans, 1,100 of which defaulted within one year.
It expected to pay "hundreds of millions of dollars more" in the future on another 7,500 more loans currently in default but insurance claims have yet to be filed or paid.
Germany's biggest bank rejected the charges and pledged to mount a vigorous defence.
"The suit is unfounded and we intend to defend ourselves vigorously against this action," a Deutsche Bank spokesman told news agency AFP, declining to comment further.
In late trading on the Frankfurt stock exchange, shares in Deutsche Bank were down 2.21 percent at €43.22.