Let’s talk about JP Morgan!

Again!

Exactly. First the London Whale, now this. I hear about JP Morgan scandals more often than I talk to my mom. What’s happening with JP Morgan today?

First, your priorities seem screwed up. You really need to call your mom more often, because there is really just no excuse.

Second, this is a whale-free development. This all comes down to JP Morgan paying penalties for everything it did wrong with mortgages during the financial crisis. Some of that was at JP Morgan itself, and most of it was at Bear Stearns and Washington Mutual, two banks that JP Morgan bought in 2008.

JP Morgan is paying, in total, penalties of $13bn, which is the biggest fine a bank has ever paid.

I’m not easily impressed, but $13bn sounds like all the money in the world.

It’s a lot, even in terms of a big bank, but there are two reasons that JP Morgan would pay so much. The first is that the bank is getting a bargain compared to what dozens of lawsuits would cost if they kept dragging on, not to mention the damage that would be inflicted on its stock price if the Justice Department decided to sue.

The second reason is that JP Morgan can afford it. The bank has revenues of $21bn a year, and over $2tn of assets. In fact, during the three months of negotiations, JP Morgan was initially going to pay $9bn, then that was upgraded to $11bn, and now it’s $13bn. That can only happen because JP Morgan has such deep pockets.

Is all that $13bn going to the same place? All for the same thing?

No, it’s going to be broken up into buckets. JP Morgan is in trouble with so many different investors and regulators that it was more convenient to lump them together into one “global” settlement. But the profits will be split differently.

Discuss.

Well, here’s how the Justice Department divvies it up:

“Of the record-breaking $13 billion resolution, $9 billion will be paid to settle federal and state civil claims by various entities related to RMBS. Of that $9 billion, JPMorgan will pay $2 billion as a civil penalty to settle the Justice Department claims under the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA), $1.4 billion to settle federal and state securities claims by the National Credit Union Administration (NCUA), $515.4 million to settle federal and state securities claims by the Federal Deposit Insurance Corporation (FDIC), $4 billion to settle federal and state claims by the Federal Housing Finance Agency (FHFA), $298.9 million to settle claims by the State of California, $19.7 million to settle claims by the State of Delaware, $100 million to settle claims by the State of Illinois, $34.4 million to settle claims by the Commonwealth of Massachusetts, and $613.8 million to settle claims by the State of New York.”

JPMorgan Chase CEO Jamie Dimon. Photograph: Mark Wilson/Getty Images Photograph: Mark Wilson/Getty Images

So, in English?

Okay, well, roughly $9bn is going to all those agencies and $4bn is going to help homeowners.

I noticed that $4bn is going to the Federal Housing Finance Agency. Why so much to them?

The FHFA oversees Fannie Mae and Freddie Mac.

I hear about Fannie and Freddie but I’m not quite sure what they do. How did they fall in with JP Morgan?

They do a lot of different things, but the most important is this: Fannie and Freddie are the middlemen between regular consumers who sign up for mortgages and banks. Fannie and Freddie’s main jobs are to keep mortgages affordable for regular people, and they do that by guaranteeing some of the risk that banks take on when they buy mortgages. If you’re interested in the full history – complete with FDR and the New Deal – you can see here.

Ever since the financial crisis, Fannie and Freddie are wards of the government. The FHFA is their godfather. The FHFA said that JP Morgan, Bear Stearns and Washington Mutual dumped $33bn of bad mortgages on Fannie and Freddie without being clear about how bad the mortgages were. JP Morgan didn’t admit that it misled Fannie and Freddie. It is paying the fine to wrap the whole thing up.

Paying a $5.1bn fine to get rid of $33bn of bad mortgages is a pretty sweet deal, though. I mean, why aren’t they responsible for the whole $33 billion?

You’re right in one respect: JP Morgan could have been on the hook for even more. Overall it is paying just about 6.2% of its losses, according to this smart WSJ analysis.

But, but, but: the key concept here is that JP Morgan didn’t admit wrongdoing. So it’s $33bn worth of allegedly misleading Fannie and Freddie. It’s a kind of official-guilt discount.

Hmmph.

Welcome to the world of government settlements. Still, it’s a pretty good score for the FHFA. Usually banks don’t pay fines that big for something they can get out of, legally.

So you said there were other buckets. Is any of this money going to, I don’t know, real people who were hurt in the mortgage crisis?

Yes, about $4bn is going to homeowners. Half of that is going to people who were hurt when they were unfairly foreclosed on.

The other half, per the New York Times, “JPMorgan has agreed to reduce interest rates on existing loans, offer new loans to low-income home buyers and keep those loans on its books. The bank will also receive credit for demolishing abandoned homes and other efforts focused on curbing urban blight.”

People pass JPMorgan's Manhattan headquarters, worried they might be asked to pitch in on the settlement. Photograph: Spencer Platt/Getty Images Photograph: Spencer Platt/Getty Images

Okay, that makes me feel better. Will that money actually go to homeowners, however? I mean, I know they said it would, but what kind of impact will that really have?

The sad part is that, if history is any indication, the impact will be 1) hard to measure and 2) falling short of expectations. Remember the $25bn national settlement with five banks last year? The banks settled charges that they used bad paperwork. So far, those banks have “fulfilled only 80% of their obligations,” to homeowners, according to the New York Times.

Now, that’s not dire – it means that they’re $15.5bn of the way through on the $19bn they owe homeowners. But the other part of the settlement that was meant for states to distribute to homeowners did not go that way.

Okay, so that’s $5.1bn and another $4bn of today’s settlement accounted for, so $9bn. What’s the last $4bn going towards?

Well, one report says $2bn is going to “prosecutors in Sacramento”, according to one account, and another roughly $2bn is going to credit unions in a few states as well as the attorney general of New York, Eric Schneiderman, and the attorney general of California, Kamala Harris as well as a few others here and there.

I’m sorry, Sacramento is getting $2bn? Just Sacramento? What on earth?

Fun fact: it’s actually Sacramento that started all this. The prosecutors in Sacramento were the first to make the case against JP Morgan in August, and then the Justice Department in Washington got wind of it, and then the other regulators piled on.

And yes, that’s quite a chunk of change: Sacramento’s entire operating budget this year is just $838.6 million, which makes the settlement money huge. But that money is really going to the Justice Department, which will likely deposit it with the US Treasury.

Poor Sacramento. All that work and then the money goes to Washington.

Yeah. But you know, their salaries come from Washington ultimately, so.

Right. And August. Jeez. I was practically teething when these settlement talks started. Now I’m growing a silvery beard. Listen, while we’re chatting, can you explain how this whole bundling-mortgages thing works?

It’s pretty easy to understand, actually, even though it has a pompous name: securitization.

It’s easiest if you think of apples. When you sign up for a mortgage, it’s like signing up to give your bank a whole apple. It used to be that one bank – the one you signed up for a mortgage from – would hold on to the apple until you paid it off.

It's a metaphor. Photograph: gardenworldimages.com Photograph: gardenworldimages.com

But if you miss your payments, what happens? That shiny mortgage apple starts rotting. Banks didn’t want rotten apples filling up their vaults, which would create slime and leave no room for fresh, clean apples.

So all the banks started bundling the mortgage apples, by throwing them in a barrel together. Then they ran the mortgage apples through a giant slicer and selling buckets of the apple slices to other banks.

Mmm, I didn’t have lunch. Apples sound tasty. But mortgages aren’t tasty. Why would the banks go to all this trouble if they didn’t even get lunch out of it?

The benefit of that method of approaching mortgages – the bundling and slicing – is that if any apple pieces rotted, they would be smaller slices and not whole apples. One bad slice wouldn’t ruin the whole basket.

But there are drawbacks. For one thing, some banks sold baskets of mortgage apples without making it clear just how many of those slices were getting ready to go bad. That’s mostly what this mortgage settlement is about. The other problem is that once you have these barrels of apple slices, it’s really hard to tell who held all the original apples. So the banks couldn’t follow the paperwork back to your specific apple, because the slices were all over the place. So the banks were just foreclosing on apple slices and hoping they were right.

You can’t foreclose on an apple.

You get the idea. The apple is a mortgage, and you can foreclose on a mortgage – even if you have just a few slices.

I think I follow now. So are we done with JP Morgan fines for the time being?

Sort of. In recent months, the bank has paid $4.5 billion for yet another set of mortgage charges, $920mn on the London Whale, and $80mn on some issues with its credit cards. There’s not too much more on the horizon. Maybe little stuff.

Thank you for this occasionally delicious conversation. Also let me know if you have a good recipe for mulled apple cider.

Totally. But first, call your mom.