The Federal Housing Finance Agency, the Congress-created conservator of Fannie Mae and Freddie Mac, operates independently of the U.S. Justice Department, which is why FHFA was able to announce its $5.1 billion settlement of securities fraud and breach-of-contract claims against JPMorgan Chase on Friday evening, before the much-ballyhooed but as yet unsigned $13 billion global deal between the bank and the government. As you know, FHFA and its lead counsel at Quinn Emanuel Urquhart & Sullivan have been whipping JPMorgan and its fellow bank defendants for as long as the conservator’s cases have been before U.S. District Judge Denise Cote in Manhattan. Facing a June 2014 trial date, and with no higher-court relief from Cote’s rulings in sight, JPMorgan had little choice but to settle FHFA’s claims that the bank and its predecessors Bear Stearns and Washington Mutual duped Fannie and Freddie about the mortgage-backed securities they were peddling. FHFA had all the leverage here.
That’s what makes one provision of the settlement so intriguing. In what I’ve heard was one of the hardest-fought sentences in the agreement, FHFA insisted that JPMorgan waive its right to seek indemnification from the Federal Deposit Insurance Corporation, which sold Washington Mutual Bank to JPMorgan in September 2008, for the $1.153 billion WaMu piece of FHFA’s $5.1 billion deal. The FDIC and JPMorgan have been fighting for years in federal court in Washington about whether the bank or the deposit insurance corporation is liable for claims based on WaMu’s deficient mortgage-backed securities, most notably in litigation in which Deutsche Bank, as the trustee of about 100 WaMu MBS trusts, has asserted a whopping $6 billion to $10 billion in put-backs. JPMorgan’s counsel at Sullivan & Cromwell, meanwhile, have sued in a related case for a sweeping declaration that the FDIC, and not the bank, is liable for all WaMu MBS claims because they weren’t on WaMu’s books when JPMorgan bought the failed bank. U.S. District Judge Rosemary Collyer of Washington has said she’ll decide in the Deutsche Bank trustee case whether JPMorgan or the FDIC is stuck with responsibility for deficient WaMu mortgage-backed securities. Discovery is under way in her court on the terms of the 2008 agreement under which JPMorgan acquired WaMu.
In Friday’s deal, FHFA could easily have ignored any potential exposure for the FDIC. Its settlement, after all, is with JPMorgan, and if the bank subsequently sued the FDIC to get back the WaMu piece of the deal, FHFA wouldn’t be affected. But instead, FHFA insisted that the bank expressly give up indemnification claims from the deposit insurance corporation for what it is paying out to Fannie and Freddie for WaMu’s toxic MBS. For the sake of appearances, if nothing else, that’s an important concession from JPMorgan.
There is, however, a very big loophole in the FHFA settlement that will permit the bank to attempt to recoup its entire WaMu payout. The FDIC provision of the FHFA agreement bars JPMorgan from seeking indemnification from the corporation – but not from the FDIC’s separate $2.7 billion WaMu receivership, which consists (roughly) of the $1.9 billion JPMorgan paid for WaMu in 2008 plus another $800 million that the fund recovered through the Chapter 11 bankruptcy of WaMu’s holding company. In the FHFA deal, the conservator agreed to a steeper discount on Fannie and Freddie’s WaMu claims than those against JPMorgan and Bear Stearns. I suspect that’s no coincidence: The allocation of FHFA’s total recovery permits JPMorgan to attempt to get all of its $1.153 billion WaMu payout from the FDIC’s WaMu receivership.
In other words, the FHFA walled off FDIC’s corporate exposure to JPMorgan indemnification claim, but it left the $2.7 billion receivership exposed to the tune of $1.153 billion.