“Well written and an interesting perspective.” Clan Rossi --- “Your article is too good about Japanese business pushing nuclear power.” Consulting Group --- “Thank you for the article. It was quite useful for me to wrap up things quickly and effectively.” Taylor Johnson, Credit Union Lobby Management --- “Great information! I love your blog! You always post interesting things!” Jonathan N.

Monday, October 28, 2013

JPMorgan: Fault and Criminal Fraud under the Settlements' Radar?

Resolving just a part of the $13 billion being demanded by the U.S. Government in court, JPMorgan capitulated in October of 2013 to a $5.1 billion settlement to resolve claims by the U.S. Federal Housing Finance Agency that the largest American bank had sold Fannie Mae and Freddie Mac mortgages and mortgage-based (i.e., derivative) securities by knowingly misrepresenting the quality of the loans and the loan-based bonds.[1]  At the time of the $5.1 billion settlement, JPMorgan’s executives were trying to settle “state and federal probes into whether the company misrepresented the quality of mortgage bonds packaged and sold at the height of the U.S. housing boom.”[2] It would seem that the bank was in a vulnerable position in the settlement negotiations, having “capitulated.” I’m not so sure.
Firstly, “JPMorgan preserved its right to seek reimbursement from the Federal Deposit Insurance Corp. for FHFA claims stemming from Washington Mutual Bank’s estate,” which at the time was managed by the FDIC.[3] The reimbursement would come out of the estate rather than the FDIC.
Secondly, it was not as though the claims against JPMorgan were only for the misdeeds of people at Bear Stearns and Washington Mutual before JPMorgan acquired them (and their problems!). Indeed, an ethical argument based on the principles of fairness and desert (as in deserving, not sugar) could be brought forward in defense of JPMorgan were the bank being asked to settle claims from the misconduct of the other two banks before being bought out. To be sure, the “fire sale” price of $2 per share (a mere 7 per cent of the market value) in acquiring Bear Stearns could justify ethically the assertion that JPMorgan ought to then cover the misconduct, even fraud, at Bear even before the bank became part of JPMorgan. In other words, the very low price per share—being so low relative to Bear’s market value—factored in the probably settlement costs. Getting a good deal and shirking the related implicit or explicit obligations is not fair—nor is it responsible, societally speaking.
To be sure, the “separate misconduct” represents only a part of the governmental claims—exactly how much of the total I do not know.  The FHFA “accused JPMorgan and its affiliates of making false statements and omitting material facts in selling about $33 billion in mortgage bonds to [Fannie and Freddie] from Sept. 7, 2005, through Sept. 19, 2007.”[4] JPMorgan had acquired Bear Stearns and Washington Mutual in 2008, so the fraud at Bear Stearns and Washington Mutual must be pre-acquisition. According to the regulator’s affidavit submitted to the federal court in Manhattan, executives at JPMorgan, Washington Mutual, and Bear Sterns “knowingly misrepresented the quality of the loans underlying the bonds.”[5] The fraud allegedly touched inside JPMorgan itself.
In 2006, for example, JPMorgan purchased 4,209 mortgages from New Century into a mortgaged-backed (i.e., derivative) security, which the bank then sold to investors including Freddie Mac (which bought about a third of the $910 million bond deal). Within a year, fifteen percent of the mortgage holders were delinquent on a payment or in bankruptcy, according to BlackBox.[6] By 2010, the 15% had turned into 50 percent. “The truth was that New Century had completely abandoned its stated underwriting guidelines,” the investors allege in a court document as support for their claim that JPMorgan bankers made false and misleading statements in testifying to New Century’s underwriting standards.[7] Given that JPMorgan had “dealt with some of the biggest subprime lenders . . . , including Countrywide, Fremont, and WMC Mortgage,” the false and misleading statements were likely not just about New Century.[8] JPMorgan was most vulnerable in this respect; the bank stood on semi-solid ground (e.g., melting permafrost) concerning the pre-acquisition, fraudulent managerial behavior at the Bear and Washington. Even so, as of October 2013, neither JPMorgan nor its bankers whom investors claim made the false and misleading statements had been charged with criminal fraud.
Thirdly, JPMorgan did not have to admit to any wrongdoing as part of the $5.1 billion settlement. This “lack of guilt” achievement points to a real or imagined vulnerability in the regulatory agencies bringing suits against Wall Street powerhouses. From this standpoint, the government capitulated. This is particularly so in this case because of the extent of lying at several banks regarding the risk of their respective mortgages produced and/or securitized into bonds.
Therefore, I would not exactly say that JPMorgan capitulated. The amount of the settlement is indeed significant, though $5.1 billion is hardly catastrophic for the largest American bank. In the judgment of William Frey, the chief executive of Greenwich Financial Services, “(w)hile these settlements seem huge, given the nature of the offenses, they are trivially small.”[9] How is it that the Wall Street giant got a mere slap on the wrist?
I propose for your consideration the hypothesis that JPMorgan did not get hit with worse in part due to the financial muscle that the bank, as well as Wall Street more generally, has in the corridors of power in Washington, D.C. More particularly, the “capture” or at least bias of regulators, who depend on the regulated for market information and regulatory feedback and who face political pressure from elected officials and their appointees, may explain more closely why JPMorgan’s potential legal liabilities have been less than typically supposed.

[1] Clea Benson and Dawn Kopecki, “JPMorgan to Pay $5.1 Billion to Settle Mortgage Claims,” Bloomberg, October 25, 2013.
[2] Ibid.
[3] Ibid.
[4] Ibid.
[5] Ibid.
[6] Al Yoon, “J.P. Morgan Talks Show Tangled Web,” The Wall Street Journal, October 28, 2013.
[7] Ibid.
[8] Ibid.
[9] Ibid.