JPMorgan: The 'Dimon Risk' Is Not Priced In

| About: JPMorgan Chase (JPM)


Jamie Dimon has overseen tens of billions in subprime legal fees and settlements.

Despite repeated bad management choices, shareholders twiddle their thumbs.

A major legal setback in two other cases sets the stage for even greater losses.

Dimon needs to go. The ongoing risk with him as CEO is not priced into the stock.

There are two things that investors should always be looking for: stocks that are selling far below intrinsic value to add to portfolios, and stocks that hold hidden risks that could result in a substantial decline. JPMorgan Chase Co. (NYSE:JPM) has ticking time bombs that could blow up in investors' faces, not to mention those they don't even know about yet, and they all go back to the mortgage crisis.

In order to assess the future impact on JPM, it is critical to understand what came before, and clear up misperceptions regarding the company during and after the mortgage crisis. Dimon is not the be-all-end-all that the financial media claims, and presents an ongoing liability to the company and shareholders.

For all the praise that JPM gets in the pages here at Seeking Alpha, it seems incumbent that this alternative viewpoint be presented. Dimon is a risk and he needs to go.

Undue Praise?

JPM dumped many of its positions in subprime mortgages before the bulk of the crisis hit. While certainly deserving of praise for this foresight, the financial media has over-hyped Dimon while doing investors a massive disservice by failing to highlight materially damaging moves.

Publications from Forbes to U.K. publications to normally hostile blogs to the New York Times have inexplicably fallen over themselves in their love for Dimon.

Yet all of this ignores some important facts: the role of the federal government (read: taxpayer) in his dealings mid-crisis, failures of management and oversight elsewhere within the corporation, and the enormous loss suffered by some JPMorgan investors despite his subprime revelation. These oversights mislead investors, and thus result in accounted-for risk.


Dimon was hailed for buying out Bear Stearns at the apex of the financial crisis, for mere pennies on the dollar. He said at the time:

JPMorgan Chase stands behind Bear Stearns. Bear Stearns's clients and counterparties should feel secure that JPMorgan is guaranteeing Bear Stearns's counterparty risk. We welcome their clients, counterparties and employees to our firm, and we are glad to be their partner.

That was only partially true, as the Fed and Treasury Department ponied up a $30 billion guarantee to entice Dimon to make the deal. We've since learned that, behind the scenes, the federal government pushed Dimon hard to make the deal. Not only that, but Dimon himself admitted in 2015 that the deal was a big mistake. The NY Post reported that:

Roughly 70 percent of JPMorgan's $19 billion [about $14 billion] of mortgage-related legal bills stems from the acquisition of Bear Stearns and another faltering firm, Washington Mutual, during the financial crisis, according to Dimon.

The massive losses associated with the deal, and being pushed into it by the feds, should give investors pause just on this matter alone. Yet, amazingly Dimon himself has said the deal was a mistake and he wouldn't do it today. In what other situation would investors give their CEO a pass for making a $14 billion mistake? The same investors that have given him passes on a host of other troubling issues.

The London Whale incident, in which the firm's chief investment office (responsible for managing risk, of all things) created a synthetic credit portfolio that blew up and resulted in $6 billion of losses, barely scratched Dimon. At a press conference regarding the trade, Dimon never accepted personal responsibility, blamed it on a London trader, and somehow still kept his job. Nobody at JPM has been convicted of a crime, although JPM has paid a $920 million fine.

While many JPM investors lucked out with the dumping of subprime securities, others were left holding the bag. In 2015, JPM reached a $388 million settlement with the Fort Worth Employees' Retirement Fund. The bank was being sued for misleading "them about the underwriting, appraisals, and credit quality of $10 billion worth of residential mortgage-backed securities it sold before the financial crisis."

Late last year, JPM settled a foreign bribery case for another $264 million, in which it was alleged that JPM provided jobs to the children of Chinese leaders as part of a deal to bring in business.

Massive Settlements

Of course, none of this mentions the $13 billion settlement with the feds for selling toxic mortgage loans that helped cause the financial crisis. This was part of the massive securitization of these bad loans that JPM engaged in, partially resulting from its acquisitions of Bear and Washington Mutual. The two lawsuits came from the Federal Housing Finance Authority - the regulator of Fannie Mae and Freddie Mac - and the other from the NY AG. Dimon knew what the risks were, and despite the $30 billion backstop, he foolishly took on the purchases of these institutions at the behest of the federal government.

In short, the CEO of JPM - who had the foresight to dump subprime assets before the crisis hit - then went and purchased two banks with tons of the same toxic loans on their books. Not only did he blow through shareholder money to purchase the institutions, he's blown through losses related to those assets, and legal and settlement fees.

But it's even worse. As reported in The Nation:

Piles of subpoenaed documents and e-mails revealed that JPMorgan bankers and traders had underwritten billions of dollars' worth of questionable mortgage-backed securities that Dimon had been telling everyone had originated at Bear Stearns and WaMu. Worse, the bad behavior had occurred on Dimon's watch.

The tally from these items just mentioned so far? $33.652 billion. And we're not even done yet.

The Unpriced "Dimon Risk"

Two other cases regarding this failure by JPMorgan are heading to trial before the New York State Supreme Court now: Orkney Re II Plc v. JPMorgan and Ballantyne Re plc v. JPMorgan. Both were victims of JPM's curious oversight, in that the pool of toxic assets that these two plaintiffs insured somehow did not get off-loaded by JPM. Indeed, the cases are so similar that they are being tried concurrently. JPM, while reducing its own exposure to the subprime market during this period, ignored Ballantyne's and Orkney's investments, resulting in losses exceeding $1 billion.

The investment of each company was overseen under a fairly standard document known as an "Investment Management Agreement", which required JPM to maintain a safe and diversified portfolio. However, as one of the lawsuits against the bank, currently being litigated in the NY State Supreme Court, states:

Despite recognizing the increasing risks of holding Subprime Securities and responding to those risks for its own account and for selected clients, JPMorgan did absolutely nothing to eliminate - or for that matter, to even reduce - the Portfolios' exposure to the Subprime Securities market.

Thus, at the same time as JPM was dumping its exposed subprime position, the managers of the Ballantyne and Orkney accounts made no changes in their subprime market exposure.

Thus, it seems the moniker of "the best team on Wall Street," (as named in the above-linked media hagiography), JPM managers were actually neglecting portfolios worth approximately $2 billion. Execution thus not only failed at the mid-level, but there was a complete failure in oversight at the top.

A Tuesday ruling by the NY State Supreme Court puts the Ballantyne case in the danger zone for JPM. The Court found that Plaintiffs' (Ambac/Ballantyne) reading of the Delaware Insurance Code was correct. Justice Scarpulla found that the Code contains a provision that limits holdings of non-agency mortgage securities to no more than 50% of the value of the relevant accounts. There is no dispute that JPM exceeded that limit by a very significant margin. Furthermore, the Court found that the provision of the Ballantyne Investment Management Agreement that provides JPM with a waiver of liability, unless there is an objection to the violation within 90 days following receipt of a statement showing the violation does not apply in this case because the statements did not, on their face, show a violation of the 50% limit. These matters were highly contested and JPM was seeking to argue during the trial that there was no 50% limit and that the account statements should have provided notice of the violation.

Given the ruling, these matters have been decided in the Plaintiff's favor and they will not have to prove either issue at trial. That is a huge blow to JPM. Furthermore, the Court did not rule on whether JPM's failure to abide by the 50% limit was the product of its gross negligence. That determination will be the subject of testimony at trial. If gross negligence is found, start counting the billions that will once again flow out of JPM's doors.

With billions of potential compensatory and punitive damages at stake on just these two cases, the possibility of additional cases coming down the pike, and a history of mismanagement by Dimon, JPM shareholders should be calling for his head.

The losses here are already massive - that's a given. What other firm could possibly survive tens of billions of dollars in losses, fines and settlements? Why is Dimon being given one pass after another? How can shareholders stand around when - based on what is obvious lack of oversight by the CEO - the risks of future losses are higher than one should normally expect?

The best thing that can happen to JPM at this point is to axe Dimon. Remove this very obvious source of risk, and replace him with someone from the outside. Conduct a thorough review of every division and report possible sources of risk.

How many more surprises do investors need?

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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