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JPMorgan's (NYSE:JPM) legal woes got a lot worse over the weekend with its well-publicized $13 billion settlement. JPM already has much more than that set aside to pay legal claims so it's really a non-event for the bank; they saw it coming to a degree. I'm not here to debate whether or not JPM's employees misled investors, including Fannie and Freddie, but what I think the most important, and disconcerting, piece of this settlement is the way it was undertaken by the Administration.

Think back to 2008 when the world as we knew it was ending. Smaller financial institutions were failing left and right and even the larger players, including Lehman, Bear Stearns, Washington Mutual, Wachovia and others eventually found themselves in enormous trouble to the point where distressed sales were the only way to stave off bankruptcy (save Lehman, of course). The federal government, eager to avoid a massive crisis, asked JPM, Wells Fargo (NYSE:WFC) and others to aid the effort to avoid such a calamity. Both obliged and we know history shows JPM ended up with Washington Mutual and Bear Stearns while Wells purchased Wachovia as it was on the cusp of going out of business. At the time, JPM CEO Jamie Dimon famously asked the government, as a favor for bailing out WaMu and Bear Stearns, not to prosecute JPM down the road for the sins of the acquired institutions. This is only fair and it should have gone without saying as the idea of prosecuting an acquirer for something the acquired company did as an independent institution is preposterous.

However, that is exactly where we find ourselves today with the settlement that has been struck. JPM has said publicly that 80% of the losses accrued from the loans that are the subject of this settlement were from Bear and WaMu. This means that, despite Dimon's asking and the fact that the federal government "urged" JPM to acquire these two institutions, JPM is indeed being punished for something it had nothing to do with. This is a watershed moment in our nation's history as the next time a financial crisis rolls around, who is going to want to help the federal government acquire failing institutions? Now that we know that the reward for such behavior is perp walks, public shaming via our lawmakers (who can't even fund their own spending) and enormous legal fines and settlements, I'm thinking it will be harder for the government to find a buyer next time.

Not only is the subject of this legal settlement and the very nature of the way it has been conducted suspect, but even the fines themselves as part of the settlement amount to nothing more than tax revenue. The $13 billion is split up as follows: $9 billion in penalties and fees and $4 billion in consumer relief. The penalties and fees are ostensibly for the "wrongdoing" that JPM must have performed in order to be subject such a historic settlement. These penalties and fees are for allegedly misleading investors in these securities and misrepresenting the strength of the underlying loans. The buyers of these securities, however, were all very sophisticated themselves, including the government sponsored entities. These companies had analysts working on these securities purchases and could very well have realized that the underlying loans were bad. However, Fannie and Freddie blindly purchased the mortgages and were eventually saddled with large losses as a result. But instead of the GSE's taking responsibility for bad investment decisions, the government has decided to simply confiscate $13 billion from a private sector company while Fannie and Freddie have claimed zero responsibility whatsoever for their role in the losses.

The other $4 billion is earmarked for "consumer relief" but the worst part of this is that these loans were sold to institutions. This means that this consumer relief is simply a bogus way to confiscate more money from JPM and the alleged reason has no basis in reality. The consumer relief portion would suggest that JPM misled the individual consumers taking the loans that were eventually securitized but that is not what the settlement is about. In fact, this is simply a way to redistribute wealth and the Administration is taking full advantage. In order for the redistribution of wealth to make the alleged victims whole it would need to be distributed among the institutions that purchased the securities. So is this part of the settlement, under the guise of "consumer relief", really just another tax levy? Or is it going to consumers that had absolutely nothing to do with this case? Either way, it's confiscatory and doesn't make any sense. Based on reports about this consumer relief portion of the settlement, this money is going wherever the Administration sees fit. In other words, this is simply tax revenue that is being redistributed and given to consumers that have absolutely zero to do with this case.

Even the $9 billion in penalties and fees is going to be distributed among various government agencies and as such, this money is also tax revenue. Otherwise, the money for these agencies would eventually come from the Treasury but instead, JPM is going to foot the bill.

I'm not against companies that have done something wrong being punished. In fact, that is a necessary part of a fair and open capitalist system that allows the free world the economic prosperity it has enjoyed over history. However, this settlement is a clear case of the federal government confiscating private assets in order to redistribute them among government operations and consumers that had absolutely nothing to do with the lawsuit. I am extremely disappointed in the way the Administration has handled this case and other banks should be on notice; it doesn't matter what you did or didn't do, if you've got the money, the government will come after you.

In terms of what this means for the stock, JPM has already set aside $23 billion for litigation reserves so when the bill comes due for this settlement, JPM has more than enough firepower available to pay it. In fact, this settlement is likely a positive for the stock. Since this is likely to be the largest of the fines/settlements handed down on the Bank of Dimon, the fact that the uncertainty has been lifted should alleviate some concern on the part of investors. In addition to this, since JPM still has a sizable reserve, $10 billion or so, left for additional litigation, investors may be surprised down the road if JPM can actually recoup some of that litigation expense and boost earnings. Not only would that remove a multi-billion drain on book value but it could also increase the bank's GAAP earnings if all litigation reserves weren't used up. In any event, even if that is not the chosen path, JPM could still recognize higher earnings in the coming quarters if it sees it needs less money set aside each quarter for litigation reserves. Again, this is very positive for the stock but for more tangible reasons.

The bottom line is that JPM got the short end of the stick with this settlement. Not only is the bank paying for the sins of others but it is paying very dearly and sustaining reputational damage in the process. I couldn't be more disappointed with the way the Administration's witch hunt was conducted and the end result. But that is the world we apparently live in now and if you want to invest in banks you need to be prepared to deal with confiscatory fines and levies against banks simply because they can't stop the government from taking it.

However, JPM is better positioned than perhaps any of its too-big-too-fail brethren to weather the storm and I think that is why there was virtually no movement in the stock when the settlement became public. JPM has been stockpiling litigation reserves when no one was looking and has done well in doing so. With the looming threat of this settlement now come and gone, investors can concentrate on what a terrific money making machine JPM is again. Trading at a small premium to book value and only nine times next year's earnings estimates, JPM is the safe choice among the TBTF banks. Couple its very cheap valuation with its robust, nearly 3% yield and the largest settlement against a single company in our country's history behind it and you've got a great potential long term buy.

Source: JPMorgan Subject To Government Confiscation, Disturbing Precedent Set