JPMorgan Settlement Offers Look Into Mortgage Machine

Milwaukee demonstration outside Chase Bank demanding a moratorium on foreclosures. The event was organized by the Bail Out the People Movement in Wisconsin. (Photo: Abayomi Azikiwe), a photo by Pan-African News Wire File Photos on Flickr.

NOVEMBER 19, 2013, 9:31 PM

JPMorgan Settlement Offers Look Into Mortgage Machine

By JESSICA SILVER-GREENBERG and BEN PROTESS
NYT

JPMorgan Chase and the Justice Department reached a record $13 billion settlement on Tuesday, wrapping up a series of state and federal investigations that offer a rare glimpse into Wall Street’s mortgage machine before the financial crisis, when it churned out billions of dollars in securities that later imploded.

At the heart of the civil settlement, which materialized after months of wrangling, is a statement of facts negotiated with the government that provides details into how JPMorgan assembled mortgage securities sold from 2005 through 2008. While the bank did not admit any violations of law, its decision to approve the statement was one of a few critical concessions it made in order to strike the deal.

The statement shows that as JPMorgan packaged the residential mortgages into complex securities, the bank promised to alert investors to any flaws that might raise questions about the loans, according to the statement.

Investors relied on the bank to vet the underlying loans, which mortgage lenders across the country originated with varying degrees of quality. Still, investors were kept in the dark, the government’s statement found.

They were told, the statement of fact says, that the lenders originating the mortgages had “solid underwriting platforms” and that JPMorgan itself would provide another level of assurance by ensuring that the loans were independently scrutinized.

To do that, the bank hired Clayton Holdings and other third-party firms to examine the loans before they were packed into investments. Poring through the mortgages, the firms scoured them for potential red flags like borrowers who had vastly overstated their incomes or appraisals that inflated property values, the statement of fact shows.

But even when problems were found, JPMorgan sometimes ignored the warnings. According to the statement of facts, an analysis for JPMorgan performed from the first quarter of 2006 through the second quarter of 2007 on 23,668 loans found that 27 percent — about 6,238 loans — should have been categorized as “event 3,” meaning they did not meet underwriting standards. Still, JPMorgan ultimately decided to accept the loans anyway or altered their classification to a higher rating.

For JPMorgan and its chief executive, Jamie Dimon, the deal allows the bank to move past one of its biggest legal headaches. While the bank continues to face a criminal investigation into its role as Bernard L. Madoff’s bank and its decision to hire the sons and daughters of some of China’s ruling elite, executives cheered the culmination of the deal on Tuesday.

“We are pleased to have concluded this extensive agreement,” Mr. Dimon said in a statement.

Signaling the bank’s broader desire to resolve its mortgage-related woes, the $13 billion deal also comes just days after the bank struck a separate $4.5 billion deal with a group of investors over the sale of soured mortgage-backed securities.

Much of the $13 billion payout, roughly $7 billion, will go toward compensating those investors who were harmed. The largest beneficiary is the Federal Housing Finance Agency, which announced a separate $4 billion deal with JPMorgan last month. The agency oversees Fannie Mae and Freddie Mac, the housing finance giants that scooped up billions of dollars in the mortgage securities that later imploded. Other beneficiaries will include the National Credit Union Administration and state attorneys general in California, New York and Illinois.

The settlement also includes a $2 billion fine to federal prosecutors in Sacramento, where the United States attorney, Benjamin Wagner, led an investigation into the bank’s mortgage practices. The final $4 billion will go to struggling homeowners in hard hit areas like Detroit and certain neighborhoods in New York where abandoned homes still dot the landscape.

Half of that relief will go to reducing the balance of mortgages in foreclosure-racked areas, offering a so-called forbearance plan to certain homeowners, briefly halting the collection of their mortgage payments. For the remaining $2 billion in relief, JPMorgan must reduce interest rates on existing loans and offer new loans to low-income home buyers. The bank also will receive a credit for demolishing abandoned homes to reduce urban blight.

“Today’s settlement is a major victory in the fight to hold those who caused the financial crisis accountable,” Eric T. Schneiderman, the New York attorney general, said in a statement.

Mr. Schneiderman has helped lead a federal and state task force focused on holding banks accountable for their mortgage practices during the financial crisis. His lawsuit against JPMorgan last year was the opening salvo in the government’s fight with the bank. Under the final settlement, he collected more than $600 million in cash and $400 million in consumer relief.

Many of the mortgage securities included in the settlement are not JPMorgan’s. Instead, they belong to Bear Stearns and Washington Mutual, which JPMorgan bought in 2008.

On a conference call on Tuesday, Marianne Lake, the bank’s chief financial officer, said that roughly 80 percent of the losses at issue in the settlement stem from Bear Stearns.

Still, the Justice Department structured the deal in a way that focused on JPMorgan’s own securities. The prosecutors in Sacramento who collected the only fine in the case were focused on mortgage securities that JPMorgan itself sold in the run-up to the financial crisis.

The $13 billion settlement took shape in recent weeks during a series of calls between Attorney General Eric H. Holder Jr. and Mr. Dimon. In the interest of expediting a deal, Mr. Dimon backed down on several important issues.

While the deal put numerous civil cases to rest, it does not save JPMorgan from any criminal inquiries into its mortgage practices. Under the terms of the deal, the bank will also have to assist prosecutors with an investigation into former employees who helped create the mortgage investments.

That agreement alone represented a significant concession for JPMorgan, which was seeking to put all of its mortgage-related cases behind it. Mr. Dimon abandoned that demand on one of his many phone calls with Mr. Holder.

At other moments, though, the bank mounted stronger objections. In a draft settlement document JPMorgan circulated to the Justice Department late last month, people briefed on the talks said, the bank sought to credit an unrelated $1.1 billion penalty toward the $13 billion settlement, a move that rankled the Justice Department.

But with the Justice Department refusing to apply the credit, the bank had to either back down or face a lawsuit. JPMorgan chose to withdraw its request.

Another flash point in the negotiations centered on mortgage securities sold by Washington Mutual. JPMorgan contends that when the bank bought Washington Mutual in 2008, the Federal Deposit Insurance Corporation agreed to shoulder some of the liabilities stemming from its failure. The Justice Department, the people said, adamantly opposed any transfer. Eventually, JPMorgan blinked.

Such sticking points threatened to scuttle the deal at several turns. As talks dragged on, the Federal Housing Finance Agency ran ahead, announcing its own deal with the bank last month. That deal effectively allows JPMorgan to try to recoup about $1 billion from the F.D.I.C.

For JPMorgan, another thorny issue involved the statements of fact included in the pact.

Those statements had to strike a delicate balance, according to two people briefed on the bank’s thinking: satisfying the government, but not stoking private lawsuits from investors.

Despite paying a string of banner settlements this year, Mr. Dimon appears to have a firm grip atop JPMorgan, according to several bank executives. The bank’s board remains steadfastly behind Mr. Dimon, who holds the dual roles of chairman and chief executive.

That support traces to a widespread belief among board members that the deals represent a victory for the bank as it tries to move past its woes.