Prosecutors sued Allied Home Mortgage Capital Corp and two top executives for at least $2.5 billion, accusing the company of a decade-long fraud in which it misled the government into believing its risky loans qualified for federal insurance.

The civil lawsuit seeks triple damages under the federal False Claims Act against Allied, which once billed itself as the largest privately held mortgage broker; Jim Hodge, its founder and chief executive; and Jeanne Stell, an executive vice president and compliance director.

It contended that Allied mortgages insured by the federal Department of Housing and Urban Development (HUD) were so poor that nearly one in three went into default. This reckless lending, it said, cost the government $834 million in insurance claims and forced thousands of homeowners out of their homes.

The losers here were American taxpayers and thousands of families who faced foreclosure because they could not make payments on mortgages that were doomed to fail, U.S. Attorney Preet Bharara in Manhattan said at a news conference. Today, Allied's business as usual comes to an end.

Reached by telephone at his Houston office, Hodge called the government's allegations so absurd. A spokesman for the company had no immediate comment.

The government said 35,801, or nearly 32 percent, of 112,324 HUD-insured mortgage loans that Allied made from 2001 to 2010 defaulted. It said 2,509 more defaulted loans could result in $363 million of further payouts. The default rate reached a staggering 55 percent in 2006 and 2007, it added.

CRACKDOWN ON LENDERS, EXECS

Tuesday's announcement is part of a government crackdown on some lenders and executives it believes contributed to the housing crisis by originating risky home loans that should not have been made, insured or sold.

Six months ago, the government accused Deutsche Bank AG in a similar, $1 billion fraud lawsuit of misleading it into insuring risky mortgages. Deutsche Bank has sought to dismiss that lawsuit.

Bharara said that the government expects to bring more lawsuits of this type. He said the case against Allied is not finished, and in response to reporters' questions left the door open for criminal action.

If and when we have sufficient evidence to bring a criminal case, we will bring it, Bharara said.

The lawsuit was filed in U.S. District Court in Manhattan, and expands upon a whistleblower lawsuit filed in May by Peter Belli, a former Allied branch manager in Massachusetts.

WHISTLEBLOWER

Belli oversaw a half-dozen Allied branch offices before being fired in 2007 after nine years at the company, court papers show. He is in other litigation with Allied over alleged unpaid commissions and expense reimbursement.

Tuesday's lawsuit is a chance to make up what they stole from him, Belli's lawyer Joe Bird said in an interview. It is also a chance for the government to make a statement to the mortgage industry that ignoring rules and harming the economy is not going to be tolerated.

Belli declined to comment when reached by phone.

In the complaint, the government also accused Allied of making many of its loans through hundreds of shadow branches that had not received HUD approval and had poor quality control. It seeks a permanent ban against such loans.

Allied had been an FHA loan correspondent until HUD shut that program at the end of 2010, the complaint said.

Hodge, meanwhile, encouraged a culture of corruption by eliminating other management, intimidating workers, and silencing former employees by suing them, the complaint said.

The U.S. lawsuit included an email that the government said Stell sent to a former Allied employee soon after a February 2009 HUD audit report faulted Allied branches.

Jim has to be the biggest target personally for his disregard for the regulations, Stell wrote, referring to Hodge. Serves him right never listening and thinking he didn't have to play by the rules.

The government said Hodge and his wife, Kathy, own 99 percent of the company, while their son Jamey owns 1 percent.

The case is U.S. ex rel. Belli v. Allied Home Mortgage Capital Corp, U.S. District Court, Southern District of New York, No. 11-05443.

(Reporting by Jonathan Stempel in New York; editing by Gerald E. McCormick, Andre Grenon and Bernard Orr)

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