Another Look at JPMorgan’s $13.1 Billion Settlement

Posted on by Jonathan Koch

Recently, JPMorgan Chase (“JPMorgan”) negotiated a tentative settlement of a record $13.1 billion with the U.S. Justice Department over mortgage lending practices.1 While some news outlets have portrayed this as politicized government overreach or anti-Wall Street zealotry2, others have argued that the government could (or should) have forced JPMorgan to pay “significantly more than thirteen billion dollars” without crippling the bank.3

Much of the disagreement over the merits of the settlement stems from the fact that the majority of the settlement arises out of the activities that occurred at Bear Stearns and Washington Mutual before JPMorgan acquired them.4 Of the entire amount, over $6 billion will compensate investors, $4 billion will provide some relief for struggling homeowners, and the remaining $2 to $3 billion represents the only part of the settlement designated as a fine. The fine portion of the settlement stems from a civil investigation of mortgage securities sold by JPMorgan itself in period preceding the financial crisis of 2008.5 The rest of the settlement (around $10 billion) will resolve a number of investigations that focused almost entirely on either Bear Stearns or Washington Mutual.6 The investigations into Bear Stearns’ focus primarily on the implementation and management of a flawed due diligence process that comprised  the quality of the underwriting process in favor of originators’ demands.7 Other investigations resolved by the settlement focus on how Washington Mutual, and to a lesser extent Bear Stearns and pre-2008 JPMorgan itself as well,  securitized poorly-vetted mortgages that did not conform to underwriting standards and then sold those mortgages “to Fannie Mae and Freddie Mac and, by extension, American Taxpayers.”8

Even for the nation’s largest bank, a $13.1 billion settlement is not trivial. However, JPMorgan has set aside over $28 billion for litigation expenses since 2010.9 This shows that the bank did indeed go into the deal with its eyes open. Furthermore, due to the settlement’s structure, it not likely that that number reflects the true impact of the deal.10 While the tax code bars deductions for fines and penalties paid to the government11, it only appears as if $2 to $3 billion of the settlement will be designated as a fine. If JPMorgan is able to classify the remainder of the settlement as compensatory or for providing restitution, the bank may be able to deduct it.12 The $4 billion of relief for mortgage borrowers is likely deductible, as is the $7 billion compensating investors.13 If this amount, roughly $11 billion, is tax deductible, the tax deduction could save JPMorgan as much as $4.18 billion, bringing the potential true cost of the settlement down near $9 billion.14 However, this might not be the case, as the government has negotiated settlements in the past that specifically forbade banks from claiming similar deductions.15

Even after facing the largest settlement of its kind, JPMorgan still appears to come out a winner. Through the use of acquisition accounting to write down Washington Mutual and Bear Stearns’ assets, JPMorgan softened the future (now current) blow from both deals.16 With Bear Stearns, JPMorgan acquired a firm with a book value of $84/share for around $10/share.17 In Washington Mutual’s case, JPMorgan paid $1.9 billion for a firm with a book value of $40 billion of shareholders’ equity that the bank valued at $3.9 billion18 Furthermore, although JPMorgan has not said exactly how much profits either acquisition has produced, using the bank’s early profit estimates, the two acquisitions may have produced as much as $16 billion in net income since years end 2008.19

All in all, because JPMorgan purchased Bear Stearns and Washington Mutual with its eyes open, as well as the potential tax deductions that may lessen the impact of the settlement, it does not appear likely that this record settlement will be more than a temporary obstacle for our nation’s largest bank or its CEO.

  1. Kim Dixon and Brian Faler, Tax Breaks Could Ease Pain of JPMorgan Deal, Politico (Oct. 22, 2013, 3:50 PM), http://www.politico.com/story/2013/10/jpmorgan-deal-tax-breaks-98688.html; see John Carney, Stop Freaking Out About the $13 Billion JPMorgan Settlement, CNBC (Oct. 23, 2013, 8:50 PM), http://www.cnbc.com/id/101133754. ↩

  2. See Carney supra (stating that “The New York Post portrays [the settlement] as a kind of bank robbery. The Wall Street Journal describes it as the government “confiscating” half of JPMorgan’s annual earnings to “appease…left-wing populist allies” of the Obama administration.”); see also Peter Eavis and Ben Protess, Considering the Fairness of JPMorgan’s Deal, Dealbook (Oct. 21, 2013, 9:32 PM), http://dealbook.nytimes.com/2013/10/21/considering-the-fairness-of-jpmorgans-deal/. ↩

  3. John Cassidy, What’s Wrong with Fining JPMorgan Chase $13 Billion, The New Yorker (Oct. 21, 2013) http://www.newyorker.com/online/blogs/johncassidy/2013/10/whats-wrong-with-fining-jpmorgan-chase-13-billion.html. ↩

  4. Ronald Barusch, Dealpolitik: Don’t Judge Dimon and the J. P. Morgan Directors by a Number, MoneyBeat (Oct. 22, 2013, 9:29 AM), http://blogs.wsj.com/moneybeat/2013/10/22/dealpolitik-dont-judge-dimon-and-the-j-p-morgan-directors-by-a-number/. ↩

  5. See Eavis, supra note 2. ↩

  6. Id. ↩

  7. Neil Irwin, Everything You Need to Know About JPMorgan’s $13 Billion Settlement, The Washington Post WonkBlog (Oct. 21, 2013, 3:49 PM), http://www.washingtonpost.com/blogs/wonkblog/wp/2013/10/21/everything-you-need-to-know-about-jpmorgans-13-billion-settlement/. ↩

  8. Id. ↩

  9. Eavis, supra note 2. ↩

  10. Dixon, supra ↩

  11. Id. ↩

  12. Id. ↩

  13. Aruna Viswanatha and David Henry, Exclusive: JPMorgan Settlement Could Cost Bank Closer to $9 Billion, Reuters (Oct. 22, 2013, 5:23 PM), http://www.reuters.com/article/2013/10/22/us-jpmorgan-penalties-idUSBRE99L19720131022. ↩

  14. Id. ↩

  15. Id. ↩

  16. Eavis, supra note 2. ↩

  17. David Benoit, Are Bear Stearns and WaMu Still Steals for J.P. Morgan?, Moneybeat (Oct. 21, 2013, 11:13 AM), http://blogs.wsj.com/moneybeat/2013/10/21/are-bear-stearns-and-wamu-still-steals-for-j-p-morgan/. ↩

  18. Felix Salmon, Making Sense of the JP Morgan Settlement, Reuters (Oct. 22, 2013), http://blogs.reuters.com/felix-salmon/2013/10/22/making-sense-of-the-jp-morgan-settlement/, (noting that “[JPMorgan] booked a $2 billion gain the minute the acquisition closed). ↩

  19. Eavis, supra note 2. ↩

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