New York's JPMorgan Chase Lawsuit: Are the Critics Right?

New York Attorney General Eric Schneiderman has filed a lawsuit [1] against JPMorgan Chase over allegations of wholesale fraud by Bear Stearns, which JPM acquired during the 2008 financial crisis. The lawsuit's critics, including Rep. Barney Frank, say the megabank shouldn't be sued because its acquistion of Bear Stearns was a "good deed."

But was it really? We have some questions about that.

One thing's for sure: If the lawsuit's dropped, that won't be a "good deed" for the investors Bear Stearns allegedly ripped off - investors that include pension funds for teachers and other public workers.

"Sack of Sh*t"

Lawsuits like this one are long overdue, given the massive evidence of widespread banker fraud. In this case it appears that Bear Stearns executives knowingly suspended underwriting rules for their loans, suspended quality controls to step up production -- one underwriter was forced to produce nearly 1,600 loans in five days -- and then lied to investors about the the loans they were bundling and selling.

The suit also alleges that Bear Stearns found defective loans during its own review process but failed to take them out of these securities, as it was required to do by contract. When it made secret settlements to its business partners, Bear Stearns then allegedly kept money that should have gone to its investors.

No bank fraud is complete without some sort of colorful obscenity from its perpetrators, and this one's no different. The suit quotes an email in which one Bear Stearns banker wrote to another regarding a trade whose ID number began with "SACO." He described the bundled securities sold by Bear Stearns as a “SACK OF SH*T,″ adding: “I hope your [sic] making a lot of money off this trade."

Our first question for the critics is this: Presumably we all agree that wrongdoing be prosecuted, and that ill-gotten gains should be returned whenever possible. Without a lawsuit, how do you propose doing justice in this case -- especially for wronged investors?

Mr. Deeds

Barney Frank fired off a press release [2] last week criticizing Schneiderman's lawsuit. "No good deed goes unpunished," Frank quipped.

"Good deed"? Dimon initially closed [3] the deal at $2 a share, although he finally paid $10 per share for a number of reasons beyond his control. The price also went up because, as the Times put it [4], "the low-ball offer cast Mr. Dimon as an unscrupulous negotiator in the eyes of envious rivals."

Apparently not everyone thought this was a "good deed" at the time.

Both Sides Now

Even as Dimon agreed to pay $10 per share, those shares were trading at $11 to $13. JPM got a good discount, his pick of top Bear Stearns employees, and even a prime piece of real estate in Bear Stearns' Manhattan skyscraper headquarters in Manhattan. And it all came at a fire sale price. There are many different ways to interpret these events - many of which aren't very flattering to Dimon or JPM.

As reported in Andrew Ross Sorkin's book Too Big to Fail and cited [5] again recently by Bloomberg News, a defensive Dimon was fearful that the public would object to a deal that looked this good, so he insisted in his own defense that his bank was taking on unknown risks. But which risks did he mean? Dimon had secured a "non-recourse" loan from the Federal Reserve for $29 billion. That means that nobody could go after JPM's assets if the mortgages turned out to be trash -- which they apparently are.

Now that a real risk has arisen, Dimon wants out of that obligation too -- and people are now saying that 2008's "good deal" is really 2012's "good deed." Evading this lawsuit would be a textbook example of "having it both ways."

But then, that's a Dimon specialty.And with that $29 billion guarantee in hand, it looks like Bear Stearns' conduct defrauded the Fed too. So far that's left JPMorgan Chase with the ill-gotten gains, and the American people with that sack of ... you know what.

Q&A

We have some questions for Rep. Frank and others with similar criticisms of this lawsuit:

If Jamie Dimon endangered or reduced his shareholders' wealth in order to perform a public service, he was in breach of his fiduciary responsibility to his shareholders. Do you believe that happened in this case?

Why does your interpretation of the facts lead you to believe that Bear Stearns or its successor companies should be exempt from lawsuit and/or criminal prosecution? Please be specific.

Your objections seem to pertain more to the sentencing or settlement phase of this case, since you describe what seem to be mitigating circumstances. Why object to the filing of a suit, rather than to its final disposition?

The bank has earned billions from this acquisition. Shouldn't the alleged injured parties get a full accounting of those profits, and shouldn't they be used to provide restitution?

The Deal

The government begged for - and financially supported - Dimon's acquisition of Bear Stearns because there were only three or four banks big enough to take on that book of business. But Citigroup was being run by incompetent executives (including former Clinton Treasury Secretary Robert Rubin),and Bank of America was on the ropes. That left only JPM, and Dimon used his position to squeeze the American people for every penny he could get.

Wait. There was one other institution that could have taken on Bear Stearns: the US government. But that, according to today's politics, would be "socialism." (Enriching people like Jamie Dimon with government resources? Not socialism.) So instead of breaking up too-big-to-fail banks, deals like the Bear Stearns acquisition made them bigger, leaving us vulnerable to future catastrophes -- and keeping us under the political thumb of Wall Street campaign contributors.

But then, JPMorgan Chase has given special consideration from the American people over and over again. It was allowed to secretly receive billions in emergency funding from the Federal Reserve and the Treasury Department, while concealing that fact from investors and bragging about its "fortress balance sheet." Dimon's bank also has a long rap sheet [6], and has paid billions in settlements and fines for fraudulent activity -- including serious large-scale crimes like forgery and bribery -- which its bankers have repeatedly committed without criminal indictments.

JPMorgan Chase has repeatedly reaped the benefits of public generosity and avoided the civil and criminal consequences of its its own actions. The government continues to protect in ways both large and small. Now that's what we call a "good deed."

Whining and Dining

An unrepentent Dimon is now celebrating the fact that JPM's profits [7] were up 34 percent in the last quarter, driven by (irony alert) improved results on mortgage lending driven by the Fed's ultra-low interest rates improved profits on mortgage lending. Once again a government institution has doped JPM up with fiscal steroids.

JPM's profits were also boosted [8] by the fact that Fannie Mae and Freddie Mac are guaranteeing and buying fewer loans, especially from smaller banks. That's given JPM the boost it needed to become the second-largest lender in the country. And to top it all off, JPM's making a bundle from state contracts for Electronic Funds Transfer to administer the government's new nutrition program for lower income children.[1]

That's two "good deeds" the American taxpayer's done for JPMorgan Chase in the last quarter alone. But that hasn't stopped Dimon from continuing to complain [7] about government "meddling," as the New York Times Dealbook column puts it, in his bank's activities.

Other Criticisms

The lawsuit has also come in for a variety of other criticisms, some more valid than others. Some commenters have picked up on comments from a JPM spokesperson who said that the suit was based on “recycled claims already made by private plaintiffs." While there's some truth to that, it's hardly a legal defense. "Surprise me" is for bartenders, not law enforcement.

The criticism hits closer to home when it comes to the idea that this lawsuit might have been filed now to give some favorable pre-election publicity to the Justice Department's Mortgage Fraud Task Force, which named as a party alongside Schneiderman in the suit. Given this Justice Department's history of Potemkin [9] bank investigations, skepticism is understandable. There are also legitimate concerns [10] about the statute of limitations, and analyses which suggest [11] the suit could have been filed earlier.

Then there's Joe Nocera in the New York Times,who slams [12] liberals criticizing Frank, comparing them to Tea Party extremists who demand "ideological purity." That's just bizarre. Liberals' willingness to criticize Frank for a wrong-headed remark can just as easily be taken as engagement in open and honest debate.[2] (There's a lot more that's wrong with this kind of thinking, but that's a topic for another day.) And while the Dodd/Frank bill may drive Wall Street execs crazy, that doesn't mean it couldn't have been a whole lot better.

Words and Deeds

When it comes to looking for upsides in this Justice Department's actions, we've been burned before. But there still could be an upside: Because the suit was filed under New York's Martin Act, bankers can be found guilty based on a pattern of misconduct. That could lead to a number of additional suits, and criminal prosecutions. If that happens that would be positive.

But time is running out.

It's true that, as David Dayen writes [13], "just because a suit gets filed doesn’t mean it will lead to anything approaching accountability." The Mortgage Fraud Task Force has repeatedly failed to deliver on its commitments, so we'll be watching this case carefully. But what's certainly true is this: If suits like this one don't get filed, there will never be any accountability.

We need more of these lawsuits, quickly. And a reminder for the Task Force: The Martin Act allows for criminal prosecutions too.
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NOTES:

[1] Peter Schweizer has an excellent write-up [14] of JPM's role in the food stamp program. JPM seems to have received a disproportionate share of state contracts, very possibly for the campaign-contribution reasons Schweizer discusses. And it appears that JPM and other vendors have done very little to stem fraud, as the program requires, despite the technology's ability to identify and flag potential misappropration of funds. (Conflict note: I have performed consulting work for private, non-bank vendors in the field of Electronic Funds Transfer.)

[2] I am a Senior Fellow with the Campaign For America's Future, one of the groups that signed that letter to Barney Frank. I did not see the letter before it was released.