Recently, The Washington Post reported that J.P.Morgan will pay $13 billion to settle lawsuits against it by the federal government and two state attorneys general. Judging from the story, the proposed settlement contains provisions that rip off taxpayers and punish the very investors victimized by the misconduct alleged. This is depressing, but perhaps not surprising from an administration that has used past mortgage settlements to rip off innocent mortgage investors, and enrich real estate speculators and irresponsible mortgage borrowers.
In the principal lawsuit that led to this proposed settlement, the government accused the biggest four banks — including J.P. Morgan Chase — of selling risky mortgage bonds to the government-sponsored mortgage giants Fannie Mae and Freddie Mac that were worth less than it appeared due to a greater-than-predicted risk that borrowers on those mortgages would default. Defaults on those mortgages later cost Fannie and Freddie money, and when those failing mortgage giants got taken over by the Federal Housing Finance Agency (which became their conservator), the FHFA sued the banks for billions (some of the many billions the federal government spent bailing out Fannie and Freddie, whose own government-backed recklessness contributed both to their own failure, and the larger financial crisis).
Instead of protecting the value of these mortgages — which the government had a duty to do as conservator for Fannie and Freddie, which owned mortgage bonds backed by those mortgages — the government does just the opposite in the proposed settlement. The Washington Post reports that the settlement requires J.P. Morgan to make the risky mortgages worth even less still, by reducing the value of those mortgages through mortgage write-downs worth $4 billion.
This “remedy” for J.P. Morgan’s conduct is worse than the disease. The government’s lawsuit alleged that the big banks ripped off mortgage investors like Fannie and Freddie by overvaluing the mortgages they invested in, mortgages whose value dropped in the mortgage crisis; now, the government is seeking to reduce the value of those mortgages even more.
Behind the government’s lawsuit is the idea that the banks made loans to mortgage borrowers who were riskier than expected, leaving investors in such loans (like Fannie and Freddie) with a loan worth less than expected due to a higher-than-projected likelihood of default. If that is so, then the banks should have charged those risky borrowers a higher interest rate and higher mortgage payments to offset their higher risk of default, not reduced their mortgage payment, as the government now seeks to do. (Ironically, such risky lending was encouraged by federal agencies like the Boston Fed, which told banks to discard traditional prudent lending criteria like lending only to people with solid credit histories, stable incomes, or enough money for a substantial down payment.)
Taxpayers suffer from this mortgage write-down “remedy,” because instead of taxpayers recovering the $4 billion, that money goes to mortgage borrowers, including those who borrowed more than was prudent (and what the bank pays to such borrowers out reduces its income, and thus, the amount of money the bank pays in corporate income taxes to the government).
The details of the settlement are not available at the time I wrote this, but one financial analyst said that part of this $4 billion in “relief is probably not even coming from J.P. Morgan, but the investors whose mortgages they service, which could include pension funds. So, as you and others have said, it’s a bounty on our 401ks.” (Previously, the Obama administration gave mortgage companies like Countrywide a financial incentive to rip off those who invested in the mortgages it serviced.) This is perverse, because those mortgage investors suffered just like Fannie and Freddie from any overvaluation of mortgages by the banks.
Money in a lawsuit brought on behalf of Fannie and Freddie should go to Fannie and Freddie to reduce the taxpayers’ cost of bailing them out. If taxpayers have suffered as a result of this risky mortgage lending, taxpayers should get this $4 billion, not borrowers many of whom gambled at what ultimately was taxpayer expense (some of whom gambled that if their home value went up, they would get to keep all the appreciation; but if it went down, they could just walk away from their mortgage — if they were in a non-recourse state like California — or otherwise shift the loss to the lender or taxpayers. In essence, heads I win, tails you lose).
If J.P. Morgan is guilty of making imprudent loans that didn’t adequately charge borrowers enough for the riskiness of the loan (which is what the complaints filed by the FHFA against the big banks suggest), then it is purchasers of those mortgage-backed securities who are victims (including the mortgage giants like Fannie and Freddie bailed out by taxpayers), not the borrowers (who were charged too little in interest, not enough, to reflect the large risk of non-repayment that the bank took in lending them money), and some of those borrowers were more like accomplices (like those who got liar loans).
I understand the perverse political reasons for this feature of the settlement (to buy votes from people who get bailed out on their mortgage), but not why journalists aren’t questioning its legal or economic (lack of) justification. The government should not be handing out money to favored borrowers that should instead be used to recoup the government’s cost of bailing out Fannie and Freddie. Congress — not the Obama administration — has the exclusive power under the Constitution to appropriate money. Effectively, the administration is appropriating money to favored constituencies in an end run around Congress.
It’s not as if the people who borrowed more than was prudent, and thus will receive mortgage writedowns under this settlement, are specially victimized by the financial crisis. Many financially prudent people who work in cyclical industries suffered far worse (like losing their job) than most imprudent mortgage borrowers, and economists across the political spectrum will tell you that although misvalued mortgage-backed securities played a key role in the 2008 financial market freeze, they were merely one of many factors that ultimately led to the overall economic crisis, like the recession the country was already mired in (rising energy prices probably did as much to tank the economy over 2007-08, by reducing disposable income and consumer spending and pushing the economy into a recession, for example. Some hedge funds, like my brother’s, were harmed more by more by higher energy prices than bad loans, for example.). Many homeowners suffered in the recession due to falling home prices, but prudent homeowners seldom received any help, even as irresponsible borrowers with higher incomes received costly taxpayer bailouts, as I explained earlier. (For a description of how government polices helped spawn the crisis — including policies perpetuated by the Obama administration — see here and here).
The settlement also must seem unfair from the perspective of J.P. Morgan’s shareholders, which include both most state pension funds, and the mutual funds held in many Americans’ 401(k) plans. First, the settlement forces J.P. Morgan to pay for a larger share of Fannie and Freddie’s losses than its market share in the mortgage market would warrant. The FHFA lawsuit alleged far less in mortgage losses due to J.P. Morgan than due to one of its less well-managed competitors that had a much larger share of the mortgage market. (Even President Obama himself once characterized J.P. Morgan as a “pretty well-managed” company.) Second, many of the losses for which the government demanded billions from J.P. Morgan are the result not of its own past conduct, but of alleged misconduct by the companies that J.P. Morgan bought at the government’s urging in the financial crisis, such as Bear Stearns and Washington Mutual. Given the possibly discriminatory treatment of the bank, a cynic might surmise that J.P. Morgan is being politically punished for being more critical of the Obama administration’s regulatory policy than some of its politically better-connected competitors.