Can JPMorgan Take What New York State Is Dishing Out?

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Let the games begin, or in this case, continue.

The New York State attorney general's office has filed suit against JPMorgan Chase (NYSE: JPM) for securities fraud committed by its Bear Stearns unit in the run-up to the financial crisis. The 31-page filing doesn't specify damages sought, but with more than $20 billion called out of lost investor money, you can bet the state will eventually be asking for billions in return.

The ghost of Bear Stearns past
In a nutshell, the suit says that JPMorgan "committed multiple fraudulent and deceptive acts in promoting and selling" residential mortgage-backed securities (the faltering debt instruments that were at the heart of the financial crash), and that "defendants failed to use due diligence as a tool to identify and eliminate the many defective loans that they purchased from originators."

Of course, it wasn't JPMorgan that committed the alleged fraud, it was Bear Stearns. Bear Stearns, if you remember, was acquired by JPMorgan on March 14, 2008 in the hastily arranged deal that saved the fast-imploding bank from bankruptcy. It's now apparent, however, that in buying Bear Stearns JPMorgan also bought the bank's ill-managed past, which, of course, is why it was imploding in the first place.

No act of kindness goes unpunished
This is the umpteenth lawsuit brought by the umpteenth prosecutor over claims arising from the financial crash. This particular one arose out of the Residential Mortgage Backed Security Working Group, set up by President Obama specifically to go after banks that had misbehaved in the run-up to the crash.

Should JPMorgan pay for the sins of Bear Stearns past? JPMorgan did get Bear for a steal: $2 per share. And the whole deal was backstopped by the Federal Reserve. Why? The Fed was nervous that a chaotic collapse of Bear might start a dangerous, economy-threatening chain reaction on Wall Street followed potentially by Main Street (which, of course, is exactly what happened six months later, after Lehman Brothers blew up).

So the backstop had to be there; with unknown billions at risk due to Bear's trading obligations, it was the only way JPMorgan would agree to it. Netted out, I think it's fair to say that JPMorgan did everyone a favor by picking up the wreckage of Bear Stearns. And if Bear Stearns hadn't managed its affairs so poorly, it never would have been trading for $2 per share.

Lawsuits gone wild
It's hard to say, in the end, what will come of the JPMorgan suit. But these kinds of things are typically settled out of court, no one admits guilt, and everyone goes away sort of content:

  • Bank of America (NYSE: BAC) just settled a shareholder lawsuit to the tune of $2.4 billion, for alleged misconduct in how it handled the acquisition of Merrill Lynch, another hastily arranged deal done in the pressure cooker of the crash. Of course, B of A officially admitted to no wrongdoing, stating that it was just trying to put the whole thing behind it. 
  • Citigroup (NYSE: C) settled a $590 million lawsuit at the end of August, brought by angry shareholders who contend they were misled about the bank's exposure to subprime mortgage debt in the run-up to the financial crisis. 
  • Even Wells Fargo (NYSE: WFC) , a bank that kept its nose cleaner than any other bank in the run-up to the crash, had to settle a $175 million lawsuit charging it had racially discriminated against mortgage applicants, shifting them toward higher rate loans when they could have just as easily gotten lower-rate loans. 

Do banks need to be held accountable for their actions? Yes, but at four years out from the crash, these types of lawsuits are beginning to feel a bit petty, and political, especially given that the misdeeds in this lawsuit were done previous to JPMorgan's purchase.

Worst case, even if JPMorgan does end up facing a multi-billion payout because of this, the bank will survive, and the stock price won't likely take much of a hit either. The London Whale debacle, a $5.8 billion mistake, didn't do lasting damage to either the bank's balance sheet or it's stock price. However this New York State filing turns out, it likely won't either.

In other banking news, check out The Motley Fool's new in-depth company report on Bank of America. It thoroughly details B of A's prospects, and gives three reasons to buy and three reasons to sell. Just click here to get access. Thanks for reading, and for thinking.

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