Monday, October 14, 2013

The (Non-)Political (Non-)Persection of JPMorgan Chase

The Washington Post tells us what some conspiracy theorists have to say about the prosecution of JPMorgan Chase for the London Whale fiasco and for the sins of its acquired companies leading up to the financial crisis:
We’re less impressed by the more backward-looking attack on JPMorgan for allegedly misleading investors about the quality of securities it marketed before the crash. Mr. Dimon reportedly is facing a demand for $11 billion in fines and other payments to settle the case, under threat of a Justice Department criminal investigation. Yet roughly 70 percent of the securities at issue were concocted not by JPMorgan but by two institutions, Bear Stearns and Washington Mutual, that it acquired in 2008. Among the investors supposedly ripped off were the sophisticated government-sponsored enterprises known as Fannie Mae and Freddie Mac. As was inevitable, some say the case is payback for Mr. Dimon’s criticism of Obama adminstration policy.
The editorial continues,
We don’t take that view; nor do we pity JPMorgan, which is still a lucrative business despite its legal woes and which purchased the institutions for their valuable assets mixed in with their massive liabilities. When it bought them, it bought their legal issues, too — known and unknown.
There's an obvious tension between the Editorial Board's whine, "70 percent of the securities at issue were concocted not by JPMorgan but by two institutions, Bear Stearns and Washington Mutual, that it acquired in 2008" and their subsequent statement, "When [JPMorgan Chase] bought them, it bought their legal issues, too — known and unknown". If they're responsible, then the percentage doesn't matter. Even if you buy into the subsequent "poor little rich boy" argument, "then-Treasury Secretary Henry M. Paulson Jr. told Mr. Dimon that doing so would help the country by stemming market panic. That gives the case a certain 'no-good-deed-goes-unpunished' quality", the companies' misconduct was not exactly a state secret at that point and potential liabilities were factored into the fire sale prices. Robert Pozen offers another version of the "poor little rich boy" stance, that admits as much,
If JPMorgan had purchased Bear Stearns under "normal" circumstances, JPMorgan's shareholders would have been a reasonable target of the lawsuit. Typically, if one corporation (call it A Corp.) buys another (call it T Corp.), A assumes all of T's former liabilities-its bonds, pension obligations, and, yes, its legal liabilities.

The transfer of legal liability relies on the logic that A could have performed due diligence prior to acquiring T, and reduced its offer price to account for any potential legal liability. Thus, the expected cost of future lawsuits flows through to T's shareholders, as it should in the normal case.

But JPMorgan's acquisition of Bear Stearns was different. JPMorgan purchased Bear Stearns at the behest of top federal officials-who needed JPMorgan to quickly announce a deal in order to quell a potential financial panic. Furthermore, the offer price was effectively set by these federal officials. There was no opportunity for JPMorgan to learn about Bear Stearns' legal liability, nor to adjust its offer price accordingly. Indeed, JP Morgan initially walked away from the acquisition because it did not have enough time for due diligence.

Thus, punishing JPMorgan's shareholders does nothing to align incentives-it merely punishes shareholders for acts in which they are blameless. Even worse, this fine discourages companies from engaging in "white knight" acquisitions at the request of federal regulators. In the future, company executives will demand broad guarantees against losses from the government before taking over any troubled institutions.
The short answer to that is that, while I feel some sympathy for a company that plays white knight and ends up with a worse deal than it anticipated, nobody forced JPMorgan Chase to say "yes". Pozen admits that they understood the risk and chose to go forward with the purchase anyway. As for their being a fixed price and no room to negotiate, clearly there were negotiations - JPMorgan Chase was free to walk away, did so, reconsidered, and came back to close the deal. Further, the facts belie the notion that the government presented JPMorgan Chase with a "take it or leave it" price - they had initially agreed to pay $2/share, and it was the threats of Bear Stearns shareholders to fight the sale that inspired them to raise their offer to $10/share. The total selling price was less than the value of Bear Stearns' Manhattan headquarters - you can't look at the negotiations or the purchase price without recognizing that JPMorgan Chase knew it was taking on potentially massive liabilities.

As for future "white knights" being afraid to step forward, let's be honest: JPMorgan Chase acted because it saw a business opportunity. Pozen and the Washington Post Editorial Board assume that JPMorgan Chase was unaware of the possible downside. I don't attribute that level of incompetence to its negotiators, and have little doubt but that they carefully considered outcomes far worse than the present proposed fines when they agreed to buy Bear Stearns at a stock valuation of 7.5% of its 52 week high.

But more than that, if the Board sincerely does not endorse the view of the conspiracy theorists, the unidentified "some" who "say the case is payback for Mr. Dimon’s criticism of Obama adminstration policy", why did Fred Hiatt and his crew choose to title their editorial, "JPMorgan Chase’s political persecution"? Was Hiatt trying to mislead readers into believing that the Post endorses the stance of the conspiracy theorists? Does he understand what the word "persecution" means? And why are they suggesting that holding JPMorgan Chase responsible for misconduct for which they acknowledge it to have assumed liability imperils the government's reputation for impartiality? How would it be impartial for the government treat JPMorgan Chase more favorably than it would treat another, similarly situated company?

Alas, these are the types of questions that Fred Hiatt's Editorial Board can never seem to find space to answer.

1 comment:

  1. On a quasi-related topic, about which you haven't posted as of yet . . . I'm curious what, if anything, will come out of claims that there was fraud and a breach of fiduciary responsibility (shocking, I know) in the handling of the finances of the City of Detroit between certain officials and certain large banks.

    The first time I saw the argument that the banks should forfeit their interests due to malfeasance it was on a fairly amateurish left wing "news source" and I pretty much dismissed it. Then I started to read accounts about the bankruptcy in Jefferson County which included convictions and banks agreeing to forfeit their claims . . . but hey, nothing that untoward could happen in Detroit, could it?



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