E-Mails Imply JPMorgan Knew Some Mortgage Deals Were Bad
By JESSICA SILVER-GREENBERG
J. Scott Applewhite/Associated PressJamie Dimon, JPMorgan’s chief. The bank is being sued over mortgage-backed deals.
When an outside analysis uncovered serious flaws with thousands of home loans,
JPMorgan Chase executives found an easy fix.
Rather than disclosing the full extent of problems like fraudulent
home appraisals and overextended borrowers, the bank adjusted the
critical reviews, according to documents filed early Tuesday in federal
court in Manhattan. As a result, the mortgages, which JPMorgan bundled
into complex securities, appeared healthier, making the deals more
appealing to investors.
The trove of internal e-mails and employee interviews, filed as part
of a lawsuit by one of the investors in the securities, offers a fresh
glimpse into Wall Street’s mortgage machine, which churned out billions
of dollars of securities that later imploded. The documents reveal that
JPMorgan, as well as two firms the bank acquired during the credit
crisis,
Washington Mutual and
Bear Stearns, flouted quality controls and ignored problems, sometimes hiding them entirely, in a quest for profit.
The lawsuit, which was filed by Dexia, a Belgian-French bank, is
being closely watched on Wall Street. After suffering significant
losses, Dexia sued JPMorgan and its affiliates in 2012, claiming it had
been duped into buying $1.6 billion of troubled mortgage-backed
securities. The latest documents could provide a window into a $200
billion case that looms over the entire industry. In that lawsuit, the
Federal Housing Finance Agency, which oversees
Fannie Mae and
Freddie Mac,
has accused 17 banks of selling dubious mortgage securities to the two
housing giants. At least 20 of the securities are also highlighted in
the Dexia case, according to an analysis of court records.
In court filings, JPMorgan has strongly denied wrongdoing and is
contesting both cases in federal court. The bank declined to comment.
Dexia’s lawsuit is part of a broad assault on Wall Street for its
role in the 2008 financial crisis, as prosecutors, regulators and
private investors take aim at mortgage-related securities. New York’s
attorney general,
Eric T. Schneiderman, sued JPMorgan last year over investments created by Bear Stearns between 2005 and 2007.
Jamie Dimon,
JPMorgan’s chief executive, has criticized prosecutors for attacking
JPMorgan because of what Bear Stearns did. Speaking at the
Council on Foreign Relations in October, Mr. Dimon said the bank did the federal government “a favor” by rescuing the flailing firm in 2008.
The legal onslaught has been costly. In November, JPMorgan, the
nation’s largest bank, agreed to pay $296.9 million to settle claims by
the
Securities and Exchange Commission that Bear Stearns had misled mortgage investors by hiding some delinquent loans. JPMorgan did not admit or deny wrongdoing.
“The true price tag for the ongoing costs of the litigation is
terrifying,” said Christopher Whalen, managing director at Carrington
Investment Services.
The Dexia lawsuit centers on complex securities created by JPMorgan,
Bear Stearns and Washington Mutual during the housing boom. As profits
soared, the Wall Street firms scrambled to pump out more investments,
even as questions emerged about their quality.
With a seemingly insatiable appetite, JPMorgan scooped up mortgages
from lenders with troubled records, according to the court documents. In
an internal “due diligence scorecard,” JPMorgan ranked large mortgage
originators, assigning Washington Mutual and
American Home Mortgage the lowest grade of “poor” for their documentation, the court filings show.
The loans were quickly sold to investors. Describing the investment
assembly line, an executive at Bear Stearns told employees “we are a
moving company not a storage company,” according to the court documents.
As they raced to produce mortgage-backed securities, Washington
Mutual and Bear Stearns also scaled back their quality controls, the
documents indicate.
In an initiative called Project Scarlett, Washington Mutual slashed
its due diligence staff by 25 percent as part of an effort to bolster
profit. Such steps “tore the heart out” of quality controls, according
to a November 2007 e-mail from a Washington Mutual executive. Executives
who pushed back endured “harassment” when they tried to “keep our
discipline and controls in place,” the e-mail said.
Even when flaws were flagged, JPMorgan and the other firms sometimes overlooked the warnings.
JPMorgan routinely hired Clayton Holdings and other third-party firms
to examine home loans before they were packed into investments. Combing
through the mortgages, the firms searched for problems like borrowers
who had vastly overstated their incomes or appraisals that inflated
property values.
According to the court documents, an analysis for JPMorgan in
September 2006 found that “nearly half of the sample pool” — or 214
loans — were “defective,” meaning they did not meet the underwriting
standards. The borrowers’ incomes, the firms found, were dangerously low
relative to the size of their mortgages. Another troubling report in
2006 discovered that thousands of borrowers had already fallen behind on
their payments.
But JPMorgan at times dismissed the critical assessments or altered
them, the documents show. Certain JPMorgan employees, including the
bankers who assembled the mortgages and the due diligence managers, had
the power to ignore or veto bad reviews.
In some instances, JPMorgan executives reduced the number of loans
considered delinquent, the documents show. In others, the executives
altered the assessments so that a smaller number of loans were
considered “defective.”
In a 2007 e-mail, titled “Banking overrides,” a JPMorgan due
diligence manager asks a banker: “How do you want to handle these
loans?” At times, they whitewashed the findings, the documents indicate.
In 2006, for example, a review of mortgages found that at least 1,154
loans were more than 30 days delinquent. The offering documents sent to
investors showed only 25 loans as delinquent.
A person familiar with the bank’s portfolios said JPMorgan had
reviewed the loans separately and determined that the number of
delinquent loans was far less than the outside analysis had found.
At Bear Stearns and Washington Mutual, employees also had the power
to sanitize bad assessments. Employees at Bear Stearns were told that
they were responsible for “purging all of the older reports” that showed
flaws, “leaving only the final reports,” according to the court
documents.
Such actions were designed to bolster profit. In a deposition, a
Washington Mutual employee said revealing loan defects would undermine
the lucrative business, and that the bank would suffer “a couple-point
hit in price.”
Ratings agencies also did not necessarily get a complete picture of
the investments, according to the court filings. An assessment of the
loans in one security revealed that 24 percent of the sample was
“materially defective,” the filings show. After exercising override
power, a JPMorgan employee sent a report in May 2006 to a ratings agency
that showed only 5.3 percent of the mortgages were defective.
Such investments eventually collapsed, spreading losses across the financial system.
Dexia, which has been bailed out twice since the financial crisis,
lost $774 million on mortgage-backed securities, according to court
records.
Mr. Schneiderman, the New York attorney general, said that overall
losses from flawed mortgage-backed securities from 2005 and 2007 were
$22.5 billion.
In a statement shortly after he sued JPMorgan Chase, Mr. Schneiderman
said the lawsuit was a template “for future actions against issuers of
residential mortgage-backed securities that defrauded investors and cost
millions of Americans their homes.”
