JPMorgan Chase on Tuesday agreed to a mortgage settlement that will cost the bank $13 billion, a large number that will bolster the government’s claims that justice was done.
But a closer look at the mortgages involved suggests that JPMorgan may actually have secured a good deal for itself.
The government’s legal onslaught centered on billions of dollars of subprime and Alt-A mortgages â€" loans that often required little documentation â€" that were made in the years leading up to the 2008 financial crisis. JPMorgan made some of the loans itself. The other loans were originated or sold into the markets by Washington Mutual and Bear Stearns, two firms that JPMorgan bought in 2008, assuming many of their future costs, including mortgage liabilities.
The Justice Department’s main allegation is that many of these loans should never have been packaged into the mortgage bonds that were sold to investors. The mortgages, the government contends, often fell short of the standards that JPMorgan and the other two firms legally agreed to when selling the bonds to investors.
“No firm, no matter how profitable, is above the law, and the passage of time is no shield from accountability,†Attorney General Eric H. Holder Jr. said in a statement on the settlement on Tuesday.
Separate from the government-led settlement, JPMorgan reached an agreement to pay $4.5 billion to a group of investment firms that bought its mortgage-backed bonds.
The only way to assess the toughness of these settlements is to know the extent of the underlying abuses. And according to some mortgage specialists, the settlement payouts may not be adequate.
“Yes, these are big numbers for newspaper headlines,†said Jeffrey Lewis, a senior portfolio manager at TIG Securitized Asset Fund. “But relative to the losses, they could have been bigger.â€
One way to determine whether JPMorgan has gotten off lightly is to calculate the settlement payments as a percentage of the subprime and Alt-A mortgages that the bank sold. From 2004 through 2007, JPMorgan, along with Washington Mutual and Bear Stearns, sold around $1 trillion of mortgages, according to Inside Mortgage Finance, an industry publication. So far, JPMorgan has paid or set aside about $25 billion to meet claims that the loans should not have been sold. In other words, that sum is 2.5 percent of the total, though that figure could increase as the bank strikes other settlements.
Some mortgage market experts contend that the 2.5 percent is too low given the suspected quantity of loans that should never have been sold to investors.
Since the crisis, many attempts have been made to assess how many of the subprime and Alt-A mortgages inside the bonds were of too low a standard. The results are staggering.
These analyses focus on crucial features of the loans that often determine the likelihood of default. One important indicator is whether borrowers were taking out the loans to buy properties they were not going to live in. Mortgage firms like Bear Stearns were supposed to properly assess owner occupancy, but often they failed to do so. Defaults on second home mortgages were particularly high.
“The most egregious mistake was allowing borrowers to lie about their occupancy,†Guy Cecala, publisher of Inside Mortgage Finance, said
Occupancy was a focus of one of the lawsuits that was wrapped into the government settlement. The suit, brought by Federal Housing Finance Agency, alleged that, in one bond deal, 15 percent of the loans were for a second home, five times the level stated in the deal’s prospectus. Most of those loans probably defaulted, which means the ultimate loss rate on the bond was probably far higher than 2.5 percent.
Other lawsuits allege that far worse abuses occurred. Some plaintiffs even assert that practically all the loans should never have been included in some bonds issued in 2006 and 2007. For instance, in litigation against Bear Stearns, private investors, after doing analyses of the underlying mortgages, have asserted that 80 to 100 percent of the loans did meet minimum standards, according to a survey of court filings by Nomura bank.
These numbers may be exaggerated, given that they come from plaintiffs trying to maximize their chances of legal success. Still, Paul Nikodem, a mortgage-backed securities analyst at Nomura, said that the surveys might have some validity. “There is evidence of multiple breaches within loans,†he said.
The relative size of JPMorgan’s payouts also seems to depend on who is suing the bank. The bank, for example, agreed to pay the Federal Housing Finance Agency $4 billion. That is 12 percent of the $33 billion of bonds identified in the agency’s lawsuit â€" a high payout rate for a set of securities that, according to bond analysts, probably had low losses compared with subprime securities identified elsewhere in the $13 billion settlement.
All these numbers are a reminder that banks fell over themselves to lend to people who didn’t actually qualify for the loans. Some people took advantage of this and cynically obtained houses they couldn’t afford. Many were less calculating and ended up victims of foreclosure. The settlement sets aside $4 billion in mortgage relief for struggling borrowers. Advocates for struggling homeowners contend that this relief needs to be directed primarily at writing down the value of mortgages, since that action is likely to do the most to ease debt burdens. “If this settlement is to have teeth to help homeowners, 100 percent of it has to go to principal reduction,†said Bruce Marks, chief executive of Neighborhood Assistance Corporation of America.
