What Precisely Did JPMorgan Chase Do Wrong with All those Mortgages?

Nearly lost in the headlines over the $13 billion that JPMorgan Chase has agreed to pay to settle a U.S. Justice Department investigation into its mortgage practices is that the huge investment bank agreed to a statement of facts that explains--if not exactly admits--its civil liability.

The Wall Street Journal has posted the statement here.The New York Times has an interactive Dealbook posting that highlights portions of the statement and discusses the implications here.

The statement of facts was the subject to months of negotiations by squadrons of executives, officials and lawyers on both sides, spells out over 11 pages what went wrong in the mortgage department.

The key findings and practice lessons will depend on where you sit in the transaction pipeline.  But a few highlights stood out for us:

  • The bottom line is stark--"employees of JPMorgan, Bear Stearns, and [Washington Mutual] received information that, in certain instances, loans that did not comply with underwriting guidelines were included in the [residential mortgage-backed securities] sold and marketed to investors; however, JPMorgan, Bear Stearns, and WaMu did not disclose this to securitization investors." In other words, they saw it, understood it, and then hid it.  JPMorgan bought Bear Stearns and Washington Mutual in 2008; the mortgage practices under scrutiny by the Justice Department covered 2005-2007.
  • JPMorgan paid vendors to conduct its due diligence, which was supposed to confirm that the loans it was about to package into securities and then sell were consistent with the bank’s origination guidelines, federal state, and local laws and rules, and that the property collateral had the value represented in the appraisal. The vendors said that some of the loans didn’t meet the originators’ guidelines, didn’t have "compensating factors" to account for providing the loand, and were appraised for more “than the values derived in due diligence testing from automated valuation models, broker price opinions or other valuation due diligence methods.” JPMorgan told investors that the loans “generally” conformed to standards, and where they didn’t, a case-by-case examination was made of the compensating factors in deciding whether to include the loans.  The Justice Department found loans in every securities package it examined that weren’t in compliance and were signed off on without JP Morgan’s stated precautions.
  • In one pool, the vendor's review (which the vendor termed a “test” report), 27%-- about 6,200 of nearly 23,700 668 loans—were given the worst rating.  This "Event 3" coding meant that the loans didn’t comply with origination rules or have compensating factors.  They received the rating “in many instances because of missing documentation such as appraisals, or proof of income, employment or assets.”  Nevertheless, JPMorgan "waived" a "number of them them" into pools for later securitization and sale, "uncured."
  • Prospective customers sometimes asked for specific data on the underlying loans, and JPMorgan employees sometimes declined to provide data that they had available.
  • While Bear Stearns reviewed the loans it bought for securitization from a variety of lender-sellers, it appears to have relied more heavily on its categorization of the sellers themselves rather than the loan bona fides in marketing the securities. After suspending sellers, it still retained loans it had purchased from them for the securities it would sell, without a post-hoc evaluation of those loans.
  • The statement of facts carefully notes that the Bear Stearns and Washington Mutual practices ended in 2007, and JP Morgan did not acquire those firms’ assets until 2008. The result, as the New York Times notes today, is a strong emphasis on JPMorgan practices and procedures, moreso than on the liabilities it assumed when it bought the failed firms.

The Wall Street Journal today also analyzes the findings here.

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