JPMorgan Chase on Tuesday agreed to a mortgage settlement that will cost the bank $13 billion, a large number that will bolster the government's claims that justice was done.
That $13 billion is a record for a single company and its sheer size notches an important victory for the government. Even so, a closer look at the troubled mortgages in the settlement suggests that JPMorgan may actually have secured a good deal for itself.
The government's legal onslaught 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. JPMorgan made some of the loans itself. The 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 the firms' future costs, including mortgage liabilities.
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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 mortgages, the government contends, often fell short of the standards that JPMorgan and the other two firms legally agreed to when selling the bonds to investors.
"No firm, no matter how profitable, is above the law, and the passage of time is no shield from accountability," Attorney General Eric H. Holder Jr. said on Tuesday in a statement on the settlement.
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.
The settlement numbers give the impression that a large bank is being taken to task for abuses that led to foreclosures and helped sink the economy. But the final $13 billion figure may be as much political theater as a real attempt to right wrongs.
The only way to assess the toughness of the settlements is to know the extent of the underlying abuses. And according to some mortgage specialists, the payouts may not be adequate.
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"Yes, these are big numbers for newspaper headlines," said Jeffrey Lewis, a senior portfolio manager at TIG Securitized Asset Fund. "But relative to the losses, they could have been bigger."
One way to determine whether JPMorgan has gotten off lightly is to calculate the settlement payments as a percentage of the subprime and Alt-A mortgages sold. 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. So far, JPMorgan has paid or set aside about $25 billion to meet claims that the loans should not have been sold. That sum is 2.5 percent of the total, though the figure could increase as the bank strikes other settlements.
Some mortgage market experts contend that 2.5 percent is too low given the suspected number of loans that should never have been sold to investors.
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.
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"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.
Bear Stearns and Washington Mutual were among the worst offenders in the subprime market. But 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 on Tuesday, other banks were worried that they might be next.
"You'll have to ask them why they picked us first," JPMorgan's chief executive, Jamie Dimon, said in a public call on Tuesday afternoon with analysts, referring to government officials. "But it could've been somebody else."
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Even beyond the big numbers, the settlement served as a sad reminder that banks fell over themselves to lend to people who did not actually qualify for the loans. Some people took advantage of this and cynically obtained 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, since that is likely to do the most to ease debt burdens. "If this settlement is to have teeth to help homeowners, 100 percent of it has to go to principal reduction," said Bruce Marks, chief executive of Neighborhood Assistance Corporation of America.
—By Peter Eavis of The New York Times