One of the big news stories of the weekend is that JP Morgan and the Department of Justice, brokering a settlement of liability across multiple Federal agencies, have reached a tentative $13 billion settlement on the bank’s mortgage-related conduct in the run-up to the crisis. The terms have not been finalized because a big open item is that JP Morgan will make an admission of some sort, and the deal could still founder over that.
While the media is all agog over the prospect of the “biggest settlement evah” with a single company, concentration has risen greatly in a lot of industries, particularly banking, so bigger companies and even mild inflation means settlements should get larger over time. So size is not a metric of accomplishment. The question is what was the actual liability and is the settlement an adequate remedy? We have the same problem here as with the mortgage settlement: save for a couple of types of bad conduct, it looks as if not enough discovery was done to know the extent of the conduct and hence what an appropriate remedy would be.
And the American public’s instinct, that even a really big-sounding number isn’t adequate given all the damage done in the financial crisis, has been confirmed, at least on a general basis, by one of the most highly respected economists in the world, Andrew Haldane, the executive director of the financial stability at the Bank of England. Haldane ascertained that no fine was big enough because the banks couldn’t begin to pay for the damage they’d done. The alternative, in that case, is prohibition and other forms of aggressive regulation. Needless to say, we haven’t seen anything like that either.
In a March 2010 paper Haldane compared the banking industry to the auto industry, since both produced pollutants: for cars, exhaust fumes; for bank, systemic risk. I’ve cited Haldane’s estimate of the world wide costs before because it is critically important:
….these losses are multiples of the static costs, lying anywhere between one and
five times annual GDP. Put in money terms, that is an output loss equivalent to between $60 trillion and $200 trillion for the world economy and between £1.8 trillion and £7.4 trillion for the UK. As Nobel-prize winning physicist Richard Feynman observed, to call these numbers “astronomical” would be to do astronomy a disservice: there are only hundreds of billions of stars in the galaxy. “Economical” might be a better description.
It is clear that banks would not have deep enough pockets to foot this bill. Assuming that a crisis occurs every 20 years, the systemic levy needed to recoup these crisis costs would be in excess of $1.5 trillion per year. The total market capitalisation of the largest global banks is currently only around $1.2 trillion. Fully internalising the output costs of financial crises would risk putting banks on the same trajectory as the dinosaurs, with the levy playing the role of the meteorite.
Yves here. A banking industry that creates global crises is negative value added from a societal standpoint. It is purely extractive. Even though we have described its activities as looting (as in paying themselves so much that they bankrupt the business), the wider consequences are vastly worse than in textbook looting.
Now keeping that in mind, let’s look at what we know about the settlement:
Focus on the cash component, which is $9 billion. $4 billion is in the form of “relief to homeowners”. In the recent mortgage settlements, the non-cash component has had PR value and has been generally meaningless in economic terms. It’s certainly not a real punishment. The company gets credit for activities that are either in its financial interest (like modifying mortgages on its balance sheet to viable borrowers) , or it would have done anyhow (giving homes to cities to be bulldozed), or it should have been doing all along (short sales). These items are mainly chits that give the bank cover to write down inflated assets on their books. Oh, and the New York Times indicates that many of the borrower relief items will be tax deductible.
The FDIC might eat as much as $3.5 billion of that total, reducing the cash component to $5.5 billion. From Huffington Post:
JPMorgan Chase & Co’s possible $11 billion settlement of government mortgage probes has been complicated by a dispute with the Federal Deposit Insurance Corp over responsibility for losses at the former Washington Mutual Inc, said people familiar with the matter [...]
JPMorgan, which acquired Washington Mutual from the FDIC for $1.9 billion at the height of the financial crisis, has disputed its responsibility to cover losses incurred by investors on the failed thrift’s mortgage securities [...]
Some fear the FDIC, under pressure from the Justice Department to join a global settlement, might agree to assume liability, a move that would effectively force another government agency to absorb billions of dollars in losses [...]
“If the FDIC were to indemnify JPM as part of the government deal, it would likely reduce the rumored $11 billion by about $3.5 billion,” said Joshua Rosner, managing director of Graham Fisher, an independent research consultancy. “That would be an absurd outcome.”
The Administration is taking credit for a settlement that is in large measure due to the stubbornness of one of its favorite whipping boys, Ed DeMarco of the FHFA. Obama has been moving heaven and earth to try to dislodge DeMarco, and one of the reasons was the 17 suits that he had filed against banks for putback liability on mortgage backed securities (the claim that the reason was his refusal to permit Fannie and Freddie to provide principal modification was trumped up charges; the attack on DeMarco was to divert attention from its failure to take any action on that front). FHFA secured a $4 billion settlement Thursday; the DoJ suddenly cut a deal with JP Morgan so it could include the FHFA settlement in the total leaked over the weekend.
Even if you accept this fine on its own terms as punitive, you have to thank the FHFA for that outcome. And that’s where the “liberal” housing groups who have been savaging Ed DeMarco for years look particularly shameful. There’s no question that DeMarco’s stubbornness against principal reduction has been misguided, but you have to look at the whole picture. As a conservator for Fannie and Freddie, what fits his job title most perfectly is for him to recoup money from banks who swindled the GSEs with their mortgage bonds. And the 2011 lawsuit against 17 banks has quietly yielded fruit. In the past week, Citi paid $395 million to Freddie Mac and Wells Fargo paid Freddie $869 million. Those are over direct mortgage purchases, but it’s on top of several other settlements, both on mortgages and mortgage securities, worth several billion over the years. Even the Justice Department’s civil lawsuit against Bank of America, seen as the first between the government and a mega-bank over what caused the financial crisis, is about mortgages purchased by Fannie and Freddie. The GSEs are profitable now because of their dominance over the mortgage market. But these successful putback cases relieved taxpayers as well.
And while I don’t think much of the $4 billion in mortgage relief in this settlement, if you take it at face value, that’s over twice as much as the benefit to homeowners if DeMarco allowed principal reduction over his preferred option of principal forbearance.
While the one criminal case against JP Morgan executives is carved out, don’t hold your breath. But JP Morgan has agreed to cooperate with the Department of Justice in prosecuting former JP Morgan executives. That would include Bear Stearns officers like Tom Morano and Mike Nierenbergaccused of double dipping in a suit by mortgage guarantor Ambac against Bear and JP Morgan.
While a criminal case launched just last month against JP Morgan (and note this is the bank proper, not via Bear or WaMu, which it also acquired during the crisis), this part of the negotiations, as reported by the New York Times, does not sound promising:
While the deal would put those civil cases to rest, it would not save JPMorgan from a parallel criminal inquiry from federal prosecutors in California…The preliminary deal materialized late on Friday after Mr. Holder spoke on the phone to the bank’s top executives, including Mr. Dimon, and the general counsel, Stephen M. Cutler, one person said. Mr. Holder told Mr. Dimon that he could not shut down the criminal investigation, reiterating an argument he made when the two met last month in Washington.
Hhhm. Wonder how damaging this case might be? The public reports so far are sketchy. For instance, this account is from Reuters on September 23:
The U.S. Justice Department is preparing to sue JPMorgan Chase & Co over mortgage bonds it sold in the run-up to the financial crisis, a sign the bank’s legal troubles are not yet over.
A lawsuit, first reported by Reuters, could come as early as Tuesday, people familiar with the matter said on Monday…
It was not immediately clear whether the new charges would be civil, criminal or both.
A source familiar with the cases earlier told Reuters that the probes in the Eastern District of California involve mortgage bonds offered by JPMorgan itself and not those by companies it bought during the crisis such as Washington Mutual or Bear Stearns.
Notice the timeline. The case was to be filed “as early as Tuesday”. That’s September 24. Dimon met with Holder in person, an absolutely unheard-of concession, on September 26. And that ready-to-go case has apparently NOT been filed. So Dimon’s special pleading if nothing else appears to have delayed the filing of a civil, and given the way it is now being described in the media, probably a criminal case. This confirms that the appearances of cronyism are indeed valid. As Georgetown law professor Adam Levitin wrote:
I’m floored that Attorney General Eric Holder was willing to take a private meeting with JPMorgan Chase CEO Jaimie Dimon while the bank is under criminal investigation and negotiating an enormous civil (and possibly criminal) settlement. I can’t recall something like this meeting happening before. There’s not anything illegal about such a meeting, but the optics are really bad and underscore the privileged position of the too-big-to-fail banks.
Yes, perhaps the AG should have some level of involvement in a multi-billion dollar settlement, but I would be quite surprised if he was very hands on with it, and meeting personally with Dimon certainly adds a explicit political flavor to the settlement discussions. And it shows the special solicitious treatment and access that Dimon and JPM and other too-big-to-fail banks receive in DC.
Dimon appears to be riding it out…so far. Dimon has created the perception that he is indispensable, in part by making that so by virtue of refusing to have a successor lined up. But as Clemenceau famously said, “The graveyards are full of indispensable men.” It’s proof that JP Morgan’s board is captured that they’ve allowed him to get away with that. Every systemically important institution should have a succession plan.
Dimon’s inattentiveness to regulatory niceties may finally have cost the bank enough both financially and in bad press to rouse its recumbent board into insisting on basic prudent corporate governance steps, like grooming possible replacements and separating the CEO/chairman role. The Financial Times tallies the potential damage:
JPMorgan last week enumerated its litigation reserves – an enormous $23bn – for the first time and said that “reasonable possible losses” on top of that amount were $5.7bn. If that entire sum were paid, it would wipe out the last six quarters of profit.
While a settlement will go a ways toward wrapping up a number of JPMorgan’s mortgage-related issues, the bank is still weathering a broad wave of scrutiny. With the bank’s legal woes escalating — at least seven federal agencies, several state regulators and two foreign countries are investigating the bank — JPMorgan announced this month that it would have to allot $9.2 billion to cover legal expenses alone. The huge legal bill led the bank to report its first quarterly loss under Mr. Dimon’s leadership.
While some commentators have hailed this settlement as a new “get tough” posture on the part of the Administration, it’s so out of character that it’s just not credible, particularly since Obama is not that far away from needing donors for his Presidential library.
There have been signs for some time that even by the standards of Wall Street arrogance and overweening entitlement, that Dimon was in a class by himself. That had been tolerated because he had successfully promoted the myth of his fortress balance sheet. But as banking expert Chris Whalen has pointed out repeatedly, that’s utterly misleading. JP Morgan is a $2.4 trillion bank attached to a $75 trillion derivatives clearing operation. Where do you think the real risks lie? And do you think the balance sheet of the bank tells you much about whether its derivatives operation is adequately capitalized?
But Dimon has been behaving erratically for some time. He’s blown up at least three times at central bankers, once at Bernanke, once at Mark Carney (when he was the head of the Bank of Canada) and I’m told at a meeting at the New York Fed. Dimon and others were told the New York Fed didn’t like certain thuggish behavior relative to state and municipal privatizations it had heard the banks were engaging in. Dimon basically screamed at them that it was none of their business (I haven’t gotten enough details of the meeting to report it, otherwise I would have written it up, but I’ve gotten two separate second-hand accounts, so I’m highly confident it did happen).
So it appeared that Dimon was fully aware of his TBTF status, not just in general, but in particular as being at the helm of the biggest bank involved in tri-party repo (Bank of New York Mellon is the other large player) and has been getting too big for even his very large britches. JP Morgan is impossible to resolve and Dimon knows that. My gut is that the officialdom has become concerned about Dimon’s stewardship. He’s become (until recently) even more dismissive towards regulators. He withheld information from the OCC during the London Whale fiasco, told egregious lies to shareholders, and then dialed in his Senate testimony. The Whale trade aftermath revealed glaring deficiencies in the bank’s risk controls (appallingly short of well-understood industry basics). That was followed by the publication of Josh Rosner’s “rap sheet” that showed that the bank was in a class of its own in the number and seriousness of regulatory violations across the bank (most other banks were up to their eyeballs in mortgage-related violations but largely clean otherwise).
With that record of mismanagement, any normal board would be looking for Dimon’s head. The regulators may be trying to apply external pressure to get Dimon out on an orderly timetable, say end of 2014. I doubt that will happen based on the events thus far. The myth of Dimon’s utility persists in the media and the analyst community despite the mounting regulatory and legal costs.
But there are other shoes to drop that may change that picture. If the DoJ does file criminal charges in California, and they look to be serious, that will keep JP Morgan in the spotlight. But my money is still on the prosecution of chief investment office trader Javier Martin-Artajo. Martin-Artajo was senior enough that he was engaged in a turf war with the head of the CIO, Ina Drew, trying to wrestle authority from her. He’s thus also senior enough to speak with knowledge and authority about the CIOs practices. The DoJ may be happy to take his scalp. But good prosecutorial practice is to see if you can cut a plea bargain and go after someone more senior. If Martin-Artajo has information that implicates Ina Drew or the bank generally (which means Dimon, since he was closely involved in the CIO’s operations), Dimon’s days may indeed be numbered. We can only hope.