Thanks to a WAMU second mortgage given to OJ SIMPSON, JPMorgan Chase is nearing a $13Billion civil settlement with the Justice Department for its mortgage lending practices.  While California homeowners in financial distress will receive little or no direct benefit from the settlement, California SHORT SALE transactions and second lien releases will increase.

The government has alleged that CHASE and its acquired companies (WAMU and Bear Sterns) were offloading bad mortgages on investors (mortgage backed securities investors, and U.S. taxpayers) through their lax practices. The Federal Housing Finance Agency suit is full of details of the alleged wrongdoing, the best example of the “ultimate liar loan”:

“Fay Chapman, WAMU’s Chief Legal Officer from 1997 to 2007, relayed that, on one occasion, ‘[s]omeone in Florida made a second-mortgage loan to O.J. Simpson, and I just about blew my top, because there was this huge judgment against him from his wife’s parents.’ When she asked how they could possibly close it, ‘they said there was a letter in the file from O.J. Simpson saying ‘the judgment is no good, because I didn’t do it!'”

While $4 billion of the settlement is slated to “help” homeowners struggling with their mortgages, substantial increase in SHORT SALES transactions will primarily benefit Real Estate Pros WHO serve the needs of California Homeowners in Financial Distress.

Understanding the Lawsuit:

The case relates to origination practices not CHASE’s post-recession “robo-signing” and foreclosure practices.  That said, the settlement is likely to lead to more CHASE SHORT SALES and second mortgage releases.  The U.S. Justice Department has negotiated a dual lawsuit settlement on behalf of separate complaints filed by the New York Attorney General and the conservator of Fannie Mae and Freddie Mac.  This is not a settlement of the criminal investigations that are ongoing.

As we know, in years before the 2008 crisis, lenders were in the business of “mortgage securitization.” They would take home loans made by retail banks and mortgage brokers all over the country, pool them into 5,000 loan blocks and indirectly sell them as bonds to cash rich pension plans, governments and hedge funds.  Most securitizations investments are created pursuant to New York trust law and are offered like stock offerings pursuant to the laws and disclosure requirements also enforced by the Securities and Exchange Commission.

Before the “went under”, government-sponsored mortgage finance companies Fannie Mae and Freddie Mac (U.S. taxpayers) bought these bonds as did investors around the globe.  But these investors got “suckered” because the rating agencies (Moody’s and Standard and Poors) were in on the scam:  the rating agencies were paid by the creators of the investment pools to over-rate the bonds AAA.  This practice is still not illegal!

We obviously know a lot of the loans originated were bad. Many were subprime, meaning to people with weak credit, small down payments, or both. Many more were “Alt-A”, a category of loan quality a little better than subprime but worse than prime loans. The bond investors trusted the rating agencies and did not know how bad lending standards had become: Think OJ SIMPSON.  Many people taking out mortgage loans didn’t make as much money as they said they did or had other risk factors like a $34Million judgment for wrongful death.  The bottom line is that the red flags to suggest that borrowers wouldn’t be able to handle their mortgage got buried in the lending system.  While bond investor demand remained high, WAMU kept originating sketchy loans and Bear Sterns continued to package and sell the pools. 

Everyone got paid until the bubble popped.  More transactions meant more profit for everyone except the investors stuck with the “hot potato”.  As a result, the investors who ended up owning the risk of the bad loans– Fannie Mae and Freddie Mac (you as taxpayers), and the private investors who purchased mortgage backed securities (your pension plan)–ended losing money as borrowers were unable to make their mortgage payments.

The sudden losses on mortgage bonds triggered a loss of confidence in the U.S. banking and financial system and failure of AIG as a loss insurer. Securities that had been rated AAA that were revealed to be based on faulty underlying junk mortgages and losses on them prompted huge losses for big banks and investors, causing a crisis of confidence in the global banking and financial system. That in turn necessitated a $700 billion bailout of the U.S. banking system, a bailout of Fannie Mae and Freddie Mac.  As taxpayers, we are now on the hook for the $188 billion bailout of Fannie Mae and Freddie Mac necessitated because of bad mortgage bonds bought from JPMorgan and others.

One of the firms most heavily involved in the profitable business of packaging and reselling subprime mortgage-backed security bonds was Bear Stearns, then the fifth-largest U.S. investment bank. One of the most active retail mortgage lenders was Washington Mutual.  The mortgage origination fraud emanating out of WAMU’s Long Beach Mortgage is well documented.  In March 2008, Bear Stearns was on the verge of failure. In a last-minute deal to prevent the Stearns from collapsing, facilitated with a $29 billion loan from the Federal Reserve, CHASE swooped in and bought the company. Later in 2008, it bought up WAMU out of FDIC receivership. 

CHASE thought it was getting a great deal but actually purchased all of Bear Stearns’ and WAMU’s outstanding legal exposures. Treasury Secretary Hank Paulson and New York Fed President Tim Geithner encouraged these emergency acquisitions and provided the financing.  But the government didn’t have any ability to force anybody to buy these failed banks. That was evident when Lehman Brothers went bankrupt in September 2008, because they couldn’t find anyone with the ability and will to buy it. It may have turned out to be a bad bet for CHASE.

Who gets the $13 billion settlement?

While $13Billion is a lot of money even for a bank the size of CAHSE it is certainly nothing approaching a death blow. CHASE holds $2.4Billion in assets and is opening ranches on every corner throughout California.  The bank earned $32 billion in operating income in 2012, so the settlement would be equivalent to about 5 months worth of income. With the legal exposure potentially behind it despite the record-high settlement, CHASE shares have bounced to roughly $50 and $54 since word of a potential settlement.

Of the $13 billion, $9 billion is to go to fines that would ultimately end up in government coffers, helping repay taxpayers for their $188 billion bailout of Fannie Mae and Freddie Mac that was necessitated in part because of the over rated bonds they bought and which we,  as taxpayers, now own. 

The other $4 billion is to go to “help” homeowners struggling with their mortgages. You may notice who is not included in this list: The private investors (pensions, funds, other governments) who bought the majority of mortgage backed bonds stuffed with bad loans.  Many of these investors are pursuing their own lawsuits with limited success.

Depending on how the final deal is written, the bank’s actual liability could be far lower and taxpayers could find themselves subsidizing its payout. There are at least three crucial factors that could reduce the actual cost to JPM from the deal.

First, regulatory fines are tax deductible. CHASE could effectively pass close to $4 billion along to taxpayers thanks to such deductions, further deflating the cost of the $13 billion settlement and passing it on to us, the tax payer.

Second, CHASE has repeatedly insisted that it is not responsible for settlement costs relating to federally-insured bank unit WAMU despite its purchase agreement with the FDIC. CHASE still argues that it shouldn’t be liable for WaMu’s misdeeds and that the FDIC (taxpayer-funded Federal Deposit Insurance Corporation) should bear those costs. While the FDIC has successfully fought that argument in court so far, “some fear the FDIC, under pressure from the Justice Department to join a global settlement, might agree to assume liability,” the Huffington Post reports. In that event, roughly $3.5 billion of the total fines and homeowner relief expenditures in the settlement would be passed from CHASE to us, the taxpayer.

Third, the bank is not paying out $13 billion in cash. A $4 billion portion is touted to “help” homeowners struggling with their mortgages Read:  more short sales and second mortgage lien releases.  Banks have successfully manipulated other recent, highly touted mega settlements requiring “relief for struggling homeowners” to minimize both how much help homeowners get and the penalty banks actually absorb from providing it. Homeowner relief provisions in settlements require banks to indirectly benefit distressed borrowers at their own expense, such as forgiving some portion of the outstanding loan amount on thousands of mortgages. 

However, banks were allowed to “count” credits for allowing SHORT SALES and second mortgage forgiveness against their settlement obligations.  Under the landmark National Mortgage Settlement, banks were able to game the rules such that short sales, which minimize the losses to a bank without helping struggling homeowners keep their homes, were three times more common than actual principal reduction.  In effect, banks got credit for “forgiving” debt that they could not collect anyway under California law.  Banks benefit from SHORT SALES and prefer the higher proceeds they receive relative to REO re-sales.  Since junior liens are forgiven in Short Sales anyway or after foreclosure in the case of purchase money second loans, banks receive credit for doing nothing additionally to help California homeowners.  The recent CHASE settlement is expected to include similar provisions that will incentivize CHASE to satisfy its $4Billion obligation through a surge of SHORT SALE transactions and second mortgage releases.

Call Attorney J. Arthur “Joe” Roberts for details





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