Is JPMorgan’s SEC settlement the end of subprime claims?

Jun 22, 2011 15:59 UTC

The SEC announced on Tuesday that J.P. Morgan Securities LLC will pay $153.6 million to settle SEC charges that “it misled investors in a complex mortgage securities transaction just as the housing market was starting to plummet. Under the settlement, harmed investors will receive all of their money back.”

This settlement is a significant win for JPMorgan and its CEO Jamie Dimon, who once again has managed to avoid the reputational and financial damage done to other banks with very similar problems. My sources say that other large Wall Street banks with similar problems related to complex mortgage deals are likely to settle SEC claims shortly. But this is only one battle won in a longer war for survival for JPMorgan and other top banks.

Why is the icky SEC settlement a win for JPMorgan? For one thing, Goldman Sachs got tagged with a $550 million fine for the “ABACUS 2007-1″ transaction, a deal that looks a lot like the “Squared CDO 2007-1″ deal that earned JPMorgan one third of the fine. Of course in the case of the former, Goldman was the sponsor and John Paulson was the beneficial party shorting the deal as it was sold to investors.

With JPM, the bank was the sponsor of “Squared CDO 2007-1″ and Magnetar Capital was the winning, hidden short seller against the deal. Edward Steffelin seems the designated fall guy for JPM, while Fabrice Tourre seemed to play this role in the Goldman transaction. ACA Management was the collateral manager for the Goldman deal, while the now bankrupt GSC Capital played that role in the JPM deal, in effect picking the assets that went into the transaction.

In these deals, investors bought what they thought was AAA-rated security. The investors were told that a neutral collateral manager had picked the assets. But as with Paulson and Goldman in the ABACUS 2007-1 deal, the SEC says that Magnetar had undisclosed influence in picking what assets went into Squared CDO 2007-1. Apparently they really wanted to put inferior assets into the pool in order to profit.

Magnetar was reported to be involved in many of the worst collateralized debt obligations or CDOs. They often helped sponsor these deals by buying the riskiest equity piece. But they didn’t disclose that they were making a much bigger — and undisclosed — bet by using credit default swaps to bet against the rest of the deal.

The sad part is that any duty of care or disclosure was up to the banks, Goldman Sachs and JPMorgan respectively, so Magnetar is likely to avoid liability in any civil claims. The big story on this litigation involving CDOs is that we may or may not ever see proof put forward in public as to how the collateral managers got corrupted in the creation and sale of a security.

The US Attorney for the Southern District of New York, Preet Bharara, is said to be on the trail. In theory, he can make people flip and squeal in a way that the SEC can’t, but so far there is little evidence of progress. In a recent feature piece in The New Yorker by George Packer, “A Dirty Business,” Bharara is criticized for not going after the real crooks of the financial crisis — the large banks and deal sponsors. Instead Bharara has only pursued the side show of insider trading by the likes of Raj Rajaratnam and Galleon.

Now, don’t start popping the champagne corks for JPMorgan just yet. In a research note published by my firm on Tuesday, we summarize some of the civil liabilities facing the top banks and loan servicers in just one narrow area, namely claims made under the Securities Act of 1933.

At the start of the financial crisis, there was over $1 trillion in 1933 Act securities fraud claims filed against the major servicer banks. After appeals, motions to dismiss and procedural delays, there are today about $200 billion in remaining claims which are now headed toward trials later this year or in 2012.

These claims total into the tens of billions of dollars and are approaching the point where the bank defendants will need to start setting aside significant reserves for settlements. The benchmark for the settlement of ’33 Act claims is the Worldcom litigation, where payments were generally 50% of losses.

In the case of Bear Stearns, for example, some $17 billion in claims are headed for trial. As and when a settlement occurs, this tab will be presented to Jaime Dimon, who forgot to stuff the Fed with the unliquidated claims against Bear Stearns when he paid $10 per share for the crippled investment bank. But that is hardly the totality of the exposure facing JPMorgan. Add the legacy claims from Washington Mutual and the bank’s own production, and the total claims facing JPMorgan total nearly $50 billion.

And keep in mind that JPMorgan is not at the top of the list in terms of total securities fraud claims pending in the New York Courts. Names such as Bank of America and Wells Fargo also have double digit billions in claims pending against them that are now set to go to trial in the near future.

So when you hear people talking about settlements by the large banks with the SEC or various state attorneys general, remember that the real action in terms of legal risk remains the various types of investor claims against these banks, only one of which we have discussed today.


Interesting article, but it says nothing about the ultimate victims of fraudulent and predatory sub-prime lending – those who were foreclosed out of house and home.

Who gives a damn about any hundred million dollar “settlement” of Wall Street banks. They are NOT the victims, they are perpetrators of the fraud.

Posted by deLafayette | Report as abusive

Standing on the brink — of a fresh financial start

Nov 18, 2010 22:11 UTC

The opinions expressed are the author’s own.

For the past several years, governments around the world have been trying to avoid dealing with excessive debt, shrinking revenue and economic activity. The main approach has been for governments to lend their credit rating and cash to help banks and public sector entities paper over the problem, in the hope that a rising tide of economic activity will lift all boats.

Unfortunately, the efforts by the Federal Reserve and other monetary authorities to “reflate” asset prices and economic turnover have failed. The reason for this failure is a basic one, namely that once nations reach a certain level of indebtedness, each marginal increase in debt and/or the supply of fiat money has less and less impact. In the U.S., for example, the velocity or turnover of the money supply has fallen because the free flow of credit and related economic activity has been withdrawn.

The chief result of the temporizing approach to the crisis taken by the leaders of the G-20 nations has been to delay the day of reckoning and erode the credit standing of the member nations. First Greece, then Ireland and next likely Spain have been left insolvent due to efforts to prop up equally bankrupt commercial banks.

But now with the citizens of sovereign states from the Germany to California rejecting bailouts and cuts in government services, the day of reckoning is coming for the banks and creditors. But therein lies the path out of hopelessness and toward national renewal.

If you consider that the average price of a home in the U.S. has fallen by more than 25% from the peak levels of the housing boom, the fact of insolvency among our largest financial institutions is no big surprise. Indeed, one of the reasons why this writer has been so bearish on the situation facing the largest banks is that something like half of their assets are tied to housing — more if you include loans sold to investors.

The Fed has been attempting to reverse this large drop in asset values with a variety of expedients, but unfortunately the courts are open every day. Even as the U.S. central bank has used quantitative easing to artificially support asset prices in the securities markets at the macro level, the fact of liquidation and resolution is slowing eroding the capital of the biggest banks.

Likewise, as I wrote in an earlier piece for, “Bernanke conundrum is Obama’s problem,” the fact of financial insolvency makes the largest banks unwilling to refinance American homeowners, adding further deflationary pressure and thwarting Fed efforts to increase the velocity of money in the U.S. economy.

Earlier this month, Ambac Financial Group, a leading insurer of municipal bonds, was forced to file bankruptcy because claims by holders of residential mortgage backed securities (RMBS) were slowing eating away all of the company’s capital. The response by Treasury Secretary Timothy Geithner has been to try and paper over this situation and, once again, bail out the largest U.S. and European banks. The holders of RMBS with Ambac guarantees may get nothing if Secretary Geithner prevails (see “Ambac, CDS and Geithner: It’s AIG All Over Again,” The Institutional Risk Analyst, November 16, 2010).

So what is to be done? The first thing that Americans must do is to accept that the level of home prices, GDP, velocity and other indicia are not going to return to pre-crisis levels for many years to come. Once we accept this reality, then restructuring and recapitalization will become the obvious if painful choice. When I am speaking on the banking industry, I tell the audience that the task ahead is like cutting off a few fingers with a kitchen knife. The bad news is that it will hurt like hell. The good news is that the fingers, eventually, will grow back.

The Obama Administration needs to change direction and to embrace restructuring and national renewal instead of the current policy of extend and pretend. The same factors that drove Ambac into bankruptcy are working on Bank of America, Wells Fargo, JPMorganChase and will eventually force a restructuring. The sooner we start the process, the sooner the U.S. economy will recover.

Indeed, I expect that the Obama Administration will eventually, reluctantly be forced to invoke the powers under the Dodd-Frank law and restructure the top-three U.S. banks. This will be near-total losses for equity holders and haircuts for creditors, but the end result will be a solvent bank that is smaller, profitable and able to again lend.

It is important for Americans to remember that bankruptcy and liquidation are necessary steps to national renewal and economic stability. The Founders of the United States embedded bankruptcy in the U.S. Constitution for precisely this reason. The Founders knew that prolonged uncertainty and a lack of finality when it comes to insolvency was bad for society, thus they commanded Congress to create federal bankruptcy courts.

Having been through a personal restructuring a decade ago, the end result of five years of civil litigation, I do not make the recommendation of embracing restructuring lightly. But restructuring and liquidation of debt allowed me to rebuild my life. Each time that a family looses a home to foreclosure, that tragedy creates an opportunity for another family to make a fresh start. When a bank is restructured, the creditors lose money, but the bank is then able to support economic growth. And when an individual declares bankruptcy in the U.S., our Constitution provides the right for fresh start.

By speeding the process of resolving bad debts and restructuring viable companies, the U.S. courts are moving forward with the process of national renewal even though our politicians have not yet found the courage to lead the way. I suspect that this, too, is going to change and very soon. No amount of talk and obfuscation in Washington can prevent the process of liquidation underway on Main Street. Before long, the fact of renewal and restructuring at the micro level will be visible at the macro level as well, and that is good news.


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