JPMorgan Chase agreed last month to a mortgage settlement that will cost the bank $13 billion. While that amount is a record for a single company, a closer look at what the bank had done suggests that JPMorgan may actually have made a good deal for itself. The government’s investigation, and subsequent claims, centered on billions of dollars of subprime and Alt-A mortgages — loans that often required little documentation — that were made in the years leading up to the 2008 financial crisis. While JPMorgan made some of the loans itself, other loans were originated or sold into the markets by Washington Mutual and Bear Stearns, two firms that JPMorgan bought in 2008. JPMorgan assumed many of those firms’ future costs, including mortgage liabilities, and in doing so, ran a giant risk with tremendous exposure. This was a classic example of corporate greed.
The Justice Department’s main allegation is that many of these loans should never have been packaged into the mortgage bonds that were sold to investors. The government contends that the mortgages often fell short of the standards that JPMorgan and the other two firms legally agreed to when selling the bonds to investors. Attorney General Eric H. Holder, Jr., said in a statement issued when the settlement was announced:
No firm, no matter how profitable, is above the law, and the passage of time is no shield from accountability.
Separate from the government-led settlement, JPMorgan recently reached an agreement to pay $4.5 billion to a group of investment firms that bought its mortgage-backed bonds. This settled more of the bank’s liabilities. Sadly, what JPMorgan did hurt many folks. From 2004 through 2007, JPMorgan, along with Washington Mutual and Bear Stearns, sold around $1 trillion of mortgages, according to Inside Mortgage Finance, an industry publication. Obviously, that’s a huge number and it puts the settlement in the proper perspective.
Thus far, JPMorgan has paid or set aside about $25 billion to meet claims that the loans should not have been bundled and sold. That sum, while quite large, is only 2.5 percent of the total amount of the loans. While the $25 billion could actually increase as the bank reaches other settlements, it will still be a small percentage of the table. Some mortgage market experts contend that 2.5 percent is too low given the suspected number of loans that should never have been made and certainly should not have been sold to investors. The New York Times, in an article, explained the situation:
Since the crisis, many attempts have been made to assess how many of the subprime and Alt-A mortgages inside the bonds were below underwriting standards. The estimates are staggering. These analyses focus on crucial features of the loans that often determine the likelihood of default. One important indicator is whether borrowers were taking out the loans to buy properties they were not going to live in. Mortgage firms like Bear Stearns were supposed to properly assess owner occupancy, but often they failed to do so. Defaults on second-home mortgages were particularly high. “The most egregious mistake was allowing borrowers to lie about their occupancy,” Guy Cecala, publisher of Inside Mortgage Finance, said.
Occupancy was a focus of one of the lawsuits that was wrapped into the government settlement. The suit, brought by the Federal Housing Finance Agency, contended that in one bond deal, 15 percent of the loans were for a second home, five times the level stated in the deal’s prospectus. The borrowers of most of those loans probably defaulted, which means the ultimate loss rate on the bond was probably far higher than 2.5 percent. Other lawsuits allege far worse abuses. Some plaintiffs even assert that practically all the loans should never have been included in some bonds issued in 2006 and 2007. For instance, in litigation against Bear Stearns, private investors, after analyses of the underlying mortgages, have asserted that 80 to 100 percent of the loans did not meet minimum standards, according to a survey of court filings by Nomura.
These numbers may be exaggerated, given that they come from plaintiffs trying to maximize their chances of legal success. Still, Paul Nikodem, an analyst of mortgage-backed securities at Nomura, said that the surveys might have some validity. “There is evidence of multiple breaches within loans,” he said. The relative size of JPMorgan’s payouts also seems to depend on who is suing the bank. The bank, for example, agreed to pay the Federal Housing Finance Agency $4 billion. That is 12 percent of the $33 billion of bonds identified in the agency’s lawsuit — a high payout rate for a set of securities that, according to bond analysts, probably had low losses compared with subprime securities identified elsewhere in the $13 billion settlement.
As we have written in prior issues, Bear Stearns and Washington Mutual were among the worst offenders in the subprime market. But unfortunately they weren’t alone. There were plenty of other big subprime players — Countrywide Financial, Merrill Lynch and even foreign institutions like Deutsche Bank and Royal Bank of Scotland – among them. After the settlement details emerged, and the media started analyzing the settlement and reporting, other banks appeared to be worried that they might be next in line.
This settlement by J.P. Morgan is a sad reminder that banks aggressively made loans to folks who did not actually qualify for the loans. Corporate greed clearly drove this train. Admittedly, some people did take advantage of the way the banks were operating and purchased houses they could not afford. Many were less calculating and ended up victims of foreclosure. The settlement sets aside $4 billion in mortgage relief for struggling borrowers. Advocates for struggling homeowners contend that this relief needs to be directed primarily at writing down the value of mortgages. That makes sense because that is likely to do the most to ease debt burdens. Bruce Marks, chief executive of Neighborhood Assistance Corporation of America, observed: “If this settlement is to have teeth to help homeowners, 100 percent of it has to go to principal reduction.”
Hopefully, this settlement will actually help both the homeowners who were victimized and the investors who bought the so-called mortgage securities. But if the settlement winds up being better for J.P. Morgan than for its victims, then a settlement that favored wrongdoers instead of their victims would serve to encourage other corporate cheaters to cheat, pay a fine or settlement, and then keep on cheating. Time will tell whether this settlement was a “good one” for victims.
Source: New York Times
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