Have Financial Regulators Finally Grown Some Teeth?


JPMorgan Chase & Co. (NYSE:JPM), America’s largest bank by assets, had to set aside so much money for legal reserves in the third quarter that the firm reported a net loss for the first time since Jamie Dimon took charge in late 2005. The bank reported a loss of 17 cents per share, a far cry from the average analyst estimate of $1.19 per share and a direct result of a $9.15 billion pretax charge for corporate legal expenses.

“While we had strong underlying performance across the businesses, unfortunately, the quarter was marred by large legal expense,” Dimon said. “We continuously evaluate our legal reserves, but in this highly charged and unpredictable environment, with escalating demands and penalties from multiple government agencies, we thought it was prudent to significantly strengthen them.”

His comments proved to be somewhat prescient. Just days after the underwhelming third-quarter report, news broke that JPMorgan could be facing a record-setting $13 billion settlement with U.S. financial regulators. Sources told Reuters that the settlement would lay to rest claims related to the sale of faulty mortgage-backed securities during the financial crisis.

If finalized, the settlement would be the largest penalty ever paid by a single financial institution. The charge would eat away more than half of JPMorgan’s $23 billion legal expense reserve, leaving the firm with $10 billion set aside to deal with the remaining litigation it faces, which could cost the bank an estimated $5.7 billion or more. For comparison, JPMorgan earned net income of $21.3 billion in 2012.

Critically, the tentative deal does not free the bank of possible criminal liability. Combined with the relatively massive financial penalties, regulators have earned themselves what is perhaps their largest victory to date in their effort to prosecute banks for their role in the late-2000s financial crisis.

The “win” could lend some much-needed momentum to regulators who are still pursuing litigation against other major financial institutions like Bank of America (NYSE:BAC), Royal Bank of Scotland (NYSE:RBS), and Deutsche Bank (NYSE:DB). All three have been targeted by the U.S. Federal Housing Finance Agency, which oversees Freddie Mac and Fannie Mae, for selling faulty mortgage-backed securities to the mortgage-finance companies.

The Royal Bank of Scotland sold more than $30 billion to the agency, while Deutsche Bank sold about $14 billion. Bank of America faces up to $57.5 billion in claims, the largest of any single financial institution, and regulators could use the JPMorgan deal as a template to extract huge penalties from the bank.

Bank of America, Royal Bank of Scotland, and Deutsche Bank are just some of the 18 banks the Federal Housing Finance Agency sued in 2011, claiming that, all told, banks sold as much as $200 billion in faulty mortgages during just four years to Fannie and Freddie.

Investing Insights: Will a Tentative Agreement Offer JPMorgan Chase a Boost?