The True Accountability in the JPMorgan Settlement

The watchword in the Justice Department’s $13 billion settlement with JPMorgan Chase over the sale of questionable mortgage-backed securities is “accountability.” References to accountability appear 11 times in the news release detailing the resolution of federal and state cases against the bank over how it packaged faulty mortgages and sold them to investors.

Attorney General Eric H. Holder Jr. said that “the passage of time is no shield from accountability,” while Tony West, the associate attorney general, stated that “we are demanding accountability” through the settlement. New York’s attorney general, Eric T. Schneiderman, added, “We’ve won a major victory today in the fight to hold those who caused the financial crisis accountable.”

The question is, accountable to whom, and for what? The case does not involve a criminal charge against JPMorgan that would typically be resolved through a deferred prosecution agreement requiring a company to affirm that its conduct was illegal. Thus, the bank asserted in a presentation to investors that it “did not admit to any violations of the law.”

Under the settlement agreement, JPMorgan “acknowledges” a statement of facts that details shoddy practices used in approving mortgages that were then put into securities that lost much of their value when the housing market collapsed. But an acknowledgment is not an admission, the type of legal hairsplitting the bank can use to claim it did not violate the law in other lawsuits related to its conduct in this area.

The settlement is intended to resolve a range of civil claims against the bank. There is a $2 billion civil penalty for violations of the mail and wire fraud statutes under the Financial Institution Reform, Recovery and Enforcement Act, a provision that allows the Justice Department to pursue cases involving banks up to 10 years after the violation. While a significant amount, the penalty is hardly a deterrent to future misconduct.

The $13 billion also includes an earlier settlement to pay $4 billion related to claims filed on behalf of Fannie Mae and Freddie Mac by the Federal Housing Finance Agency, which oversees the companies. Those two had their own problems with misleading disclosure to investors about their holdings of questionable mortgages, and each entered into nonprosecution agreements with the Securities and Exchange Commission in December 2011 to resolve investigations.It is hard to view Fannie Mae and Freddie Mac as victims when they also contributed to the collapse of the housing market.

Nearly $2 billion of the settlement goes to the National Credit Union Administration and the Federal Deposit Insurance Corporation to compensate them for losses suffered by failed banks and credit unions that the two regulators had to take over. And more than $1 billion goes to five states that filed civil claims against JPMorgan for violations of their laws in the sales of mortgage securities.

Those payments can be justified as a penalty for wrongdoing and compensation for investors so that the bank is being held accountable for transgressions. But the fact is that buyers of the securities peddled by JPMorgan and two financial institutions it acquired in 2008, Bear Stearns and Washington Mutual, were sophisticated buyers, not mom-and-pop investors.

The real accountability in the settlement is a separate provision requiring JPMorgan to help those harmed by the collapse of the mortgage market: homeowners struggling to pay mortgages that often exceed the value of their home. The sales of mortgage securities helped fuel the housing bubble, and its collapse caused harm to many who had nothing to do with subprime mortgages and those without proper income documentation, the “liar loans.”

The agreement requires the bank to provide $4 billion in relief by reducing the principal balance and interest rate on qualifying mortgages, with extra credit given for modifications on properties in what are termed “hardest hit areas,” like Detroit. JPMorgan will also receive credit for lending in low- and moderate-income areas, and for taking actions to relieve blight, like paying the cost of demolishing houses and donating land to local municipalities and nonprofit organizations.

Rather than just relying on JPMorgan to undertake these measures on its own, the settlement agreement requires the appointment of an outside monitor to report on the bank’s progress each quarter. If its various efforts to provide relief to consumers do not result in the full $4 billion in benefits, then the bank will be required to donate the shortfall to NeighborWorks America, a nonprofit organization. So rather than only promising to do good, the bank has to actually follow through or pay the difference.

No one should be misled into concluding that JPMorgan will be paying out of its pocket all the money that this part of the settlement requires. Reducing the principal owed on a mortgage or its interest rate affects the value of the loan but does not require an immediate expenditure in most cases. Moreover, the program can actually benefit the bank because keeping a borrower in a house who continues to pay the mortgage, even at a reduced rate, is superior to foreclosing on the property and suffering a far greater loss in most instances.

Those to whom JPMorgan will provide assistance would not have a basis to pursue a claim against the bank for its misconduct. So they would not ordinarily be part of the settlement of a case or receive any direct benefit from it.

While criminal fines and civil penalties make for big headlines, they often have little real effect on the company or victims of its violation, being treated as little more than a traffic ticket. The Justice Department took a creative approach to resolving the case that allows for a measure of accountability to those who suffered from JPMorgan’s mortgage practices, at least indirectly but no less importantly than investors in the mortgage securities.

The settlement with JPMorgan will be a template for resolving cases with other banks over sales of mortgage securities. That means the emphasis will be less on imposing big fines and more on finding ways to funnel assistance to those hit the hardest by the collapse of the housing market.