If you are Jamie Dimon, a good deal is apparently never good enough.
The New York bank filed suit yesterday against the FDIC over an inability to reach agreement over who is liable for various claims against WaMu. I have not yet read the underlying suit, but the account in the Wall Street Journal, which was first to report on the litigation, makes the underlying bone of contention sound fairly simple.
The legal issue at stake is alleged ambiguity of contract language. Per the Journal:
J.P. Morgan is seeking a portion of the $2.7 billion remaining in the receivership, which includes $1.88 billion J.P. Morgan paid for Washington Mutual’s branches and deposits…
The assets in the receivership should be “sufficient,” J.P. Morgan said in its lawsuit, to cover everything from a settlement with mortgage-finance companies Fannie Mae and Freddie Mac to injuries sustained by a woman who slipped on a ceramic tile outside a Washington Mutual branch to millions in unpaid state taxes….
J.P. Morgan reiterated in its lawsuit that it separately expects the FDIC receivership to cover any potential damages resulting from a private lawsuit brought by Deutsche Bank National Trust Co. seeking as much as $10 billion on behalf of more than 100 trusts holding poorly performing bonds issued by Washington Mutual. J.P. Morgan and the FDIC already have disagreed in that case over who ultimately is liable for those claims….
The disagreements between J.P. Morgan and the FDIC can be traced back to the frenzied hours before J.P. Morgan acquired Washington Mutual’s banking operations on Sept. 25, 2008. The final agreement lacked a list of specific liabilities included and excluded from the sale—an unusual arrangement when compared with pacts drawn up to resolve other large institutions that were seized during the financial crisis.
One section stated that J.P. Morgan agreed “to pay, perform and discharge all the liabilities of the Failed Bank which are reflected on the Books and Records of the Failed Bank as of Bank Closing,” but the key phrase “Books and Records” was never defined in the document.
The Financial Times states that the Morgan bank is trying to get the FDIC receivership to eat the cost of 24 lawsuits. Of those, it’s highly probable that the overwhelming amount of the damages sought result from the Deutschebank litigation, plus Fannie and Freddie putback suits. And my guess is that the FDIC has a good change of arguing successfully that these are included in “books and records”. Fannie, Freddie, and Deutsche are all invoking broadly similar provision in the contracts that governed mortgage securitizations sponsored by WaMu: that if mortgages fell short of the various attributes (like FICO scores and loan to value ratios) “represented” in the contract governing the deal , the pooling and servicing agreement, that the trustee, on behalf of investors, could put it back to the originator, WaMu. That meant either replacing the bad mortgage with a good one or paying the equivalent cash amount. A lot of mortgages worse than the investors were promised adds up to a lot of money due them if they go after dodgy originators like WaMu.
Now all mortgage securitizations had putback language, each and every one. The language was broadly similar. So JP Morgan can hardly claim to be unaware of this risk; they had it in their own securitizations, and WaMu was a major subprime bond sponsor. So the question is whether WaMu’s records are considered to include the pooling and servicing agreements it entered into. I’d love to see JP Morgan’s argument, but I find it hard to fathom how they aren’t part of the deal. MBS Guy concurred: “I haven’t read the underlying deal docs and JPM/DB/FDIC litigation recently, but when I did I distinctly recall thinking that the language was not vague – JPM was on the hook. ”
JP Morgan also works in a political argument that is really hard to stomach, namely that it was doing the FDIC a huge favor. It’s standard JP Morgan PR thrown into its lawsuit. Again from the Journal:
One key section of the agreement states the FDIC receivership “agrees to indemnify and hold harmless” J.P. Morgan for any liabilities of Washington Mutual that “are not assumed” by J.P. Morgan. In exchange, the bank said in its lawsuit Tuesday, J.P. Morgan “protected” the FDIC “from potentially unprecedented liability and helped ensure the stability of the country’s banking system.”
Now this is just hogwash. “Protected” is the JP Morgan “fortress balance sheet” writ large, that if the big strong bank hadn’t stepped in as rescuer, the government (or in this case, the FDIC, which as we will see are not exactly the same thing) would have been in a world of hurt, lost for other options.
The fact is that JP Morgan itself was able to do this deal in September of 2008 only by virtue of the Federal rescue of the repo system by backstopping money market funds. The media and most crisis historian fail to acknowledge that JP Morgan, as one of the critical players in the tri-party repo system, was extremely vulnerable to the impact of counterparty failures. One of the early alphabet soup facilities, the Primary Dealer Credit Facility (implemented in the wake of the Bear collapse) and even more directly, the backstopping of money market funds (announced by the Treasury six days before the WaMu deal was inked) were bailouts of the repo system, and thus JP Morgan above all.
And not only wasn’t JP Morgan the big strong savior Jamie Dimon pretends it was, the FDIC wasn’t desperate either. Georgetown law professor Adam Levitin explains by e-mail:
Technically, JPM wasn’t taking the FDIC “off the hook” via WaMu. The FDIC itself is never “on the hook”. Instead, the Deposit Insurance Fund (DIF), a mutual insurance fund for the banking industry, was on the hook for insured deposits, and nothing more. FDIC as receiver has no liabilities of its own. It only pays out from the DIF (for insured deposits). The DIF is then subrogated to the claims of the insured depositors against the remaining assets of the failed bank, which the FDIC as receiver distributes among the various claimants according to their priorities. The parties on the hook were thus the DIF (meaning all banks because it is a mutual insurance and fund) and WaMU’s uninsured creditors, which were presumably a lot of other financial institutions owed money for everything from MBS rep and warranty claims to securities claims to breach of contract claims (for various payment obligations, e.g.). I assume there were also some large, uninsured deposits, but many of these fled WaMu before its collapse (indeed, the flight of deposits hastened WaMu’s collapse).
All of this is to say that JPM is being coy about how the FDIC is actually structured. It might be hard for the FDIC to argue about this, however, because the FDIC likes to pretend that deposits are “Back by the Full Faith and Credit of the United States”. That’s simply false. No statute makes deposits backed by the Full Faith and Credit of the United STates. Instead, it is the FDIC’s own obligations, not the DIF’s insurance obligations that are backed by Full Faith and Credit, but the FDIC itself is rarely on the hook for anything. That’s why FDIC logos don’t say what is backed by Full Faith and Credit. This arrangement keeps the FDIC’s liabilities off the federal balance sheet. Of course, the deposits are implicitly guaranteed by the US, but that’s another matter.
If the DIF runs dry, the FDIC presumably looks to the entire banking industry to cough up some more cash. So JPM was hardly protecting the FDIC itself from liability. It was only agreeing to eat losses (to the extent it so agreed) that would otherwise fall on other financial institutions (including possibly on JPM), but JPM did this as the price of getting a bunch of WaMu assets. The point here, is that JPM was not doing the taxpayers a solid. It was making a calculated business gamble that benefitted other banks, not the public fisc. Only if the banking industry as a whole were to run dry and be unable to answer DIF capital calls would the government’s implicit guarantee be lined up, but at that point Armageddon would have happened. This is all kind of academic, however. The lack of an explicit Full Faith and Credit deposit guarantee is not something the FDIC wants to advertise too loudly, however, so I doubt they will call JPM on this.
And the worst of this sorry behavior by JP Morgan is that by any account, it has done well by the WaMu acquisition. Felix Salmon gave a recap in October:
JP Morgan has made billions of dollars in profit on these deals, even after paying this settlement [the pending $13 billion settlement].
If you have any doubt about this, just look at the accounting. WaMu had shareholders’ equity of some $40 billion, before it was bought, which JP Morgan paid $1.9 billion for. JPM valued that equity at $3.9 billion, so it booked a $2 billion gain the minute that the acquisition closed; it then said that WaMu would contribute about $2.5 billion per year in extra profits going forwards.
The point here is that JPM fully expected that legacy WaMu assets would generate some $36.1 billion in losses. Now that those losses are starting to appear, all that we’re seeing is the arrival of something which was expected and priced in all along.
In reality, Washington Mutual did better than JPM expected: the bank is going to take a $750 million gain this quarter to reflect the outperformance of WaMu mortgages. (I’ll tender a guess, here: underwater mortgages are impossible to refinance, and as a result a huge proportion of JP Morgan’s underwater borrowers are paying well above-market interest rates.)
And JP Morgan got strategic value over and above the profits: branches in the West Coast and Florida, where it was keen to have a stronger presence.
But JP Morgan is simply typical of the new ethos of Wall Street, and much of the top wealthy, who seem to have an insatiable appetite for money. The WaMu receivership is a pot of money they can try to exploit; why not have a go? It’s just another manifestation of a predatory mindset.