Considering the Fairness of JPMorgan’s Deal

Some on Wall Street have portrayed JPMorgan Chase as a victim of government zealotry.

The bank is close to striking a $13 billion settlement over mortgage practices â€" the largest sum a corporation has ever paid to resolve government investigations. Adding to the sense of injustice, the bank’s defenders say that JPMorgan is paying for the sins of two firms that it bought in the depths of the financial crisis, Bear Stearns and Washington Mutual.

But as details emerge, Wall Street’s fears of a largely punitive settlement may not add up.

While the overall sum is large, the money will flow to different parties. The largest sum, more than $6 billion, will serve as compensation for investors like pension funds that suffered losses from mortgage securities sold by JPMorgan, Bear Stearns and Washington Mutual, people briefed on the settlement talks said.

Another $4 billion will take the form of relief for struggling homeowners in cities like Detroit. The payout will serve as penance for the bank’s general mortgage practices, and does not stem from any particular mortgage securities or institution, according to one of the people briefed on the talks.

The remaining $2 billion to $3 billion will represent the only fine in the case, according to the people briefed on the talks. That fine, from federal prosecutors in Sacramento, involves a civil investigation into mortgage securities that JPMorgan itself sold in the run-up to the financial crisis. Despite the concerns that JPMorgan was being unfairly taken to task for the practices of Bear Stearns and Washington Mutual, investigations into the two firms are not expected to lead to any fines. Justice Department lawyers, one person said, decided against allocating fines to those firms because doing so might appear punitive. The government encouraged and helped arrange the two takeovers.

The people, who spoke on the condition of anonymity, cautioned that the settlement talks were ongoing and the numbers could shift somewhat.

Mortgage securities sold by Bear Stearns and Washington Mutual are a major contributor to the more than $6 billion of compensation to the investors. Some $4 billion of that is to settle a lawsuit from a federal housing regulator that accused JPMorgan, Washington Mutual and Bear Stearns of selling shoddy mortgage securities to Fannie Mae and Freddie Mac, the government-controlled mortgage finance companies.

The remaining chunk of the compensation is expected to resolve a range of investigations from state and federal authorities: a credit union association, the offices of the New York and California attorneys general, federal prosecutors in Pennsylvania and the Justice Department’s own civil division.

Those cases, the people said, focused almost entirely on either Washington Mutual or Bear Stearns. The sum of each payout is unclear. Yet in the case from the New York attorney general, Eric T. Schneiderman, JPMorgan is expected to pay more than $500 million, two people briefed on the matter said. The agencies will pass on the compensation to investors in their states.

In some ways, the compensation element of the deal allows JPMorgan to resolve actions that it might have been expected to settle in any case. The bank appears to be catching up with Bank of America, which also bought two large entities laden with problematic mortgages in 2008: Countrywide Financial and Merrill Lynch. Bank of America has taken more than $40 billion of expenses relating to mortgage securities. JPMorgan said earlier this month that, since 210, it had set aside $28 billion for litigation expenses.

Still, the claims that JPMorgan has been unfairly treated may persist. Many of the mortgage securities targeted in the settlement came from Washington Mutual and Bear Stearns before JPMorgan acquired the firms in 2008.

People in power during the crisis say that those two acquisitions were a great help to the government.

“Bear Stearns would have gone down if JPMorgan hadn’t acquired it,” Henry M. Paulson Jr., the former Treasury secretary, said earlier this month on CNBC. “If that had happened, it would have been a real disaster,” said Mr. Paulson, who helped oversee both deals.

Despite JPMorgan’s financial strength, analysts are starting to believe that high cost of the settlement could dent the bank’s performance.

“Where would the bank’s stock be trading if it were not for this stuff?” asked Richard Ramsden, a banking analyst with Goldman Sachs. “I can pretty much guarantee you it would be quite a bit higher.”

But in 2008, JPMorgan executives did not seem too worried about the Bear Stearns and Washington Mutual deals. In retrospect, the bank appears to have pursued the two firms in a way that left it vulnerable to litigation.

Little suggests that JPMorgan bought Bear Stearns and Washington Mutual against its will. It was avidly watching both in 2008, hoping to snatch them up at low prices. Mr. Paulson appeared to acknowledge JPMorgan’s benefit from the acquisitions in the interview earlier this month. “I’m not saying these things weren’t in JPMorgan’s interest,” he said. “I assume they were.”

And when JPMorgan actually did the deals, the bank told its shareholders that it had looked closely at both firms. “We believe the amended terms are fair to all sides and reflect the value and risks of the Bear Stearns franchise,” Jamie Dimon, the chief executive of JPMorgan, said in 2008.

After the Washington Mutual deal later that year, Mr. Dimon said, “Our eyes are not closed on this one.”

The big question is whether Bear Stearns and Washington Mutual have produced profits to offset the proportion of the litigation expenses that stem from both entities. JPMorgan stopped saying how much it expected each entity to make soon after it bought them. But if JPMorgan’s early profit estimates are used, Bear Stearns and Washington Mutual may have contributed $16 billion in net income since the end of 2008.

JPMorgan also used acquisition accounting in such a way that would have softened the future blow from both deals. For instance, at the time of the deal, JPMorgan estimated the future losses embedded in Washington Mutual’s operations and assets. It then wrote down Washington Mutual’s assets by more than $30 billion to reflect the perceived losses. The exercise was advantageous: it meant JPMorgan itself would not have to bear the losses after it had subsumed Washington Mutual.

While the accounting move benefited JPMorgan, its legal liabilities were another matter. In corporate America, it is common for companies to assume the legal liabilities of any entities they acquire. Acquirers can write deal terms in such a way that certain legal risks are removed. It appears JPMorgan did not take adequate steps to do this.

Still, the government’s actions could make strong banks wary of buying weak ones, holding back the healing of the financial system, according to some banking specialists.

“At this point in the cycle, consolidation would be very healthy â€" and it’s not happening,” said Jason Goldberg, a bank analyst with Barclays.