JPMorgan Mole: Bank Exaggerated Quality of Mortgages

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JPMorgan Chase (NYSE:JPM) has been slammed with numerous legal and regulatory headaches in recent months. Not only is the bank dealing with the legal repercussions of 2012’s $6 billion London Whale trading loss, it is also involved in more than a handful of separate investigations led by the U.S. Department of Justice and other government agencies that are looking into various aspects of JPMorgan’s past operations, ranging from the mortgage-backed securities it sold during the housing bubble to the bank’s alleged mistreatment of consumers during the recession.

While many cases have yet to be settled, legal expenses are adding up. The cost of a 2011 settlement concerning allegations that JPMorgan manipulated the bidding process for municipal securities is $228 million; the cost of a 2012 settlement of claims regarding mortgage-backed securities, $296.9 million; the cost of a 2013 settlement of allegations of energy-market manipulation, $410 million; the cost of settlements in 2012 and 2013 concerning the bank’s mortgage-foreclosure practices, $1.8 billion; and, the cost of the September 19 settlement with four U.S. regulators over the 2012 London Whale trading losses, $920 million.

Now, the Justice Department is pursuing criminal charges against JPMorgan for the sale of mortgage-backed securities, with the government’s case largely dependent on information from a company insider who has provided the necessary material evidence.

Through individuals familiar with the matter, The Wall Street Journal has learned that documents including emails show that the bank exaggerated the quality of mortgages that had been bundled into securities and sold to investors before the financial crisis. An individual briefed on the matter told the publication that the settlement could be as much as $11 billion, of which $4 billion would returned to investors who were misled by JPMorgan’s quality assurances. If the government pursues a higher sum, the relief portion of the total would increase.

Financial regulators are slowly amending how they prosecute institutions involved in financial crisis-era misdeeds. In the five years that have passed since Lehman Brothers went bankrupt and the federal government began handing out bailouts, lawmakers and the public have criticized regulatory agencies for not bringing more cases or sending Wall Street executives to jail for the roles they played in bringing about the meltdown.

As a result of this pressure, the Securities and Exchange Commission decided to allow fewer financial firms to settle allegations without admitting or denying the facts of cases. Similarly, the Department of Justice is pushing to elicit an admission of wrongdoing by JPMorgan Chase as part of a settlement deal, according to the Journal’s sources. It is the admission of wrongdoing that has slowed the settlement discussions so far: Those familiar with the deal told the publication that representatives of the bank are maintaining that no crimes were committed, so they will not admit to committing any crimes.

To circumvent this impasse, the two sides could make a deferred prosecution agreement, in which the bank would help government prosecutors formulate potential cases against individual executives at JPMorgan. However, the bank and the government may also come to the conclusion that an agreement on the potential criminal case is impossible, the Journal’s sources said. In that case, the Justice Department would file a civil lawsuit against the bank while continuing to pursue criminal charges.

The DoJ has been building its case against JPMorgan for a year and a half, after a broad investigation began in 2012 as part of the Obama administration’s efforts to penalize banks that misrepresented residential mortgage-backed securities. JPMorgan is also facing a lawsuit by New York Attorney General Eric Schneiderman regarding fraudulent residential mortgage-backed securities, and a case brought by the Department of Housing and Urban Development is pending, as well.

Of course, the documents provided by the JPMorgan insider help the government’s case: They indicate that the bank knowingly hawked mortgage-backed securities with underlying loans that were of lesser quality than what investors were told, individuals familiar with the investigation told the Journal. Included in the documents, according to the sources, was an email sent from a bank employee to her superiors that warned the bank was vastly exaggerating the quality of the mortgages that were bundled into securities and sold. However, the bank reportedly ignored the warning.

The woman who wrote that email is expected to be used as a witness if the case ever goes to court — and it almost did go to to court.

Early last week, tired of the lack of cooperation from JPMorgan regarding settlement negotiations and convinced of its case, the Department of Justice gave the bank a copy of the lawsuit it planned to file as early as Tuesday. In a response to attempt to disrupt the proceedings, the bank made a $3 billion settlement offer, but Attorney General Eric Holder rejected it as insufficient. Still, Holder met with JPMorgan CEO James Dimon for approximately 45 minutes on Thursday, Reuters reports. What was discussed exactly is not known, but as the Journal notes, it was centered on the legal implications of the potential settlement.

Sen. John McCain, a Republican from Arizona, expressed his concern that the attorney general had conducted high-level talks with the bank’s CEO in a letter sent to Holder on Monday. “J.P. Morgan’s misconduct seriously harmed investors, wreaked havoc on our nation’s financial security, and continues to have painful effects on homeowners. … Any government response relating to these events must hold the proper institutions and individuals accountable,” the senator wrote, according to the Journal. “Government enforcement actions must no longer be viewed by institutions and their management teams as simply the cost of doing business.”

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