Was the $9 billion Chase settlement paid to conceal fraud?

The US Justice Department used the threat of whistleblower testimony to extort an additional $6 billion out of JP Morgan Chase.

The bailouts of the too-big-too-fail banks irritated me (and many others). I would have far preferred to see the architects of the financial catastrophe of 2008 lose their jobs, their wealth, their social status, and be demonized for their atrocious behavior. Instead, we bailed them out, allowed them to keep their ill-gotten gains, and put them back in charge of our financial system. It wasn’t right.

The anger toward the banks is deeply rooted. Many people who lost their homes blame the banks (even if it was really their own fault), and many people decry the way banks were bailed out while ordinary citizens were made to suffer.

If banks were made out to be scapegoats for the misdeeds of others, they may deserve some compassion, but for the most part, the banks were guilty of widespread fraud, both systemically and though brazen acts by individual employees. The public has valid reasons for hating the banks and lamenting that justice wasn’t served.

The $9 Billion Witness: Meet JPMorgan Chase’s Worst Nightmare

By Matt Taibbi | November 6, 2014evil_toward_banks

Fleischmann is the central witness in one of the biggest cases of white-collar crime in American history, possessing secrets that JPMorgan Chase CEO Jamie Dimon late last year paid $9 billion (not $13 billion as regularly reported – more on that later) to keep the public from hearing.

Back in 2006, as a deal manager at the gigantic bank, Fleischmann first witnessed, then tried to stop, what she describes as “massive criminal securities fraud” in the bank’s mortgage operations. Thanks to a confidentiality agreement, she’s kept her mouth shut since then. …

This past year she watched as Holder’s Justice Department struck a series of historic settlement deals with Chase, Citigroup and Bank of America. The root bargain in these deals was cash for secrecy. The banks paid big fines, without trials or even judges – only secret negotiations that typically ended with the public shown nothing but vague, quasi-official papers called “statements of facts,” ….

This wasn’t a problem isolated to Chase. First, the borrowers themselves were committing fraud by filling out stated-income loan applications that were laughably bogus. Second, investors were demanding these loans despite the obvious flaws because they securities were getting AAA ratings from agencies committing fraud to obtain the business. Third, the loan originators were committing fraud by ignoring obvious underwriting problems in order to take the fraudulent loans and package them into securities where they got fraudulent ratings. Nobody involved was well behaved.

As a transaction manager, Fleischmann functioned as a kind of quality-control officer. Her main job was to help make sure the bank didn’t buy spoiled merchandise before it got tossed into the meat grinder and sold out the other end.

A few months into her tenure, Fleischmann would later testify in a DOJ deposition, the bank hired a new manager for diligence, the group in charge of reviewing and clearing loans. Fleischmann quickly ran into a problem with this manager, technically one of her superiors. She says he told her and other employees to stop sending him e-mails. The department, it seemed, was wary of putting anything in writing when it came to its mortgage deals.

If you sent him an e-mail, he would actually come out and yell at you,” she recalls. “The whole point of having a compliance and diligence group is to have policies that are set out clearly in writing. So to have exactly the opposite of that – that was very worrisome.” One former high-ranking federal prosecutor said that if he were taking a criminal case to trial, the information about this e-mail policy would be crucial. “I would begin and end my opening statement with that,” he says. “It shows these people knew what they were doing and were trying not to get caught.” …

That’s the nature of criminal activity that is condoned by everyone in the system. This manager was under pressure to deliver crappy loans to investors, and any issues of conscience were subordinated to his work of feeding the sausage grinder. He was wise enough to know how to cover his tracks, and he was evil enough to do so without regard to anyone else.

Normally, banks tried to turn loans into securities at warp speed. The idea was to go from a homeowner signing on the dotted line to an investor buying that loan in a pool of securities within two to three months. Thus it was a huge red flag to see Chase buying loans that were already seven or eight months old.

What this meant was that many of the loans in the GreenPoint deal had either been previously rejected by Chase or another bank, or were what are known as “early payment defaults.” EPDs are loans that have already been sold to another bank and have been returned after the borrowers missed multiple payments. That’s why the dates on them were so old.

In other words, this was the very bottom of the mortgage barrel. … The industry had its own term for this sort of loan product: scratch and dent. As Chase later admitted, it not only ended up reselling hundreds of millions of dollars worth of those crappy loans to investors, it also sold them in a mortgage pool marketed as being above subprime, a type of loan called “Alt-A.” … “Everything that I thought was bad at the time,” Fleischmann says, “turned out to be a million times worse.”  …

That’s the essence of fraud: selling one product while representing it as another. It’s like buying a Lexus and delivering a Toyota, or in this case a Yugo.

When Fleischmann and her team reviewed random samples of the loans, they found that around 40 percent of them were based on overstated incomes – an astronomically high defect rate for any pool of mortgages; Chase’s normal tolerance for error was five percent. One mortgage in particular that sticks out in Fleischmann’s mind involved a manicurist who claimed to have an annual income of $117,000. Fleischmann figured that even working seven days a week, this woman would have needed to work 488 days a year to make that much. “And that’s with no overhead,” Fleischmann says. “It wasn’t possible.”

Liar loans originally had a veneer of believability, but as they became more common, and as fewer and fewer of them got rejected in underwriting, the lies became more brazen and transparent, and it became more difficult for underwriters to suspend disbelief and approve the loans in good conscience.

But when she and others raised objections to the toxic loans, something odd started happening. The number-crunchers who had been complaining about the loans suddenly began changing their reports. The process she describes is strikingly similar to the way police obtain false confessions: The interrogator verbally abuses the target until he starts producing the desired answers. “What happened,” Fleischmann says, “is the head diligence manager started yelling at his team, berating them, making them do reports over and over, keeping them late at night.” Then the loans started clearing. …

This is so egregious, it’s difficult to believe.

Fleischmann testified, she approached a managing director named Greg Boester and pleaded with him to reconsider. She says she told Boester that the bank could not sell the high-risk loans as low-risk securities without committing fraud. “You can’t securitize these loans without special disclosure about what’s wrong with them,” Fleischmann told him, “and if you make that disclosure, no one will buy them.”

I think she underestimated the foolishness of investors at the time. Someone would have purchased this crap regardless, they just might have asked for a small discount, which Chase didn’t want to give.

A few weeks later, in early 2007, she sent a long letter to another managing director, William Buell. In the letter, she warned Buell of the consequences of reselling these bad loans as securities and gave detailed descriptions of breakdowns in Chase’s diligence process.

Fleischmann assumed this letter, which Chase lawyers would later jokingly nickname “The Howler” after the screaming missive from the Harry Potter books, would be enough to force the bank to stop selling the bad loans. “It used to be if you wrote a memo, they had to stop, because now there’s proof that they knew what they were doing,” she says. “But when the Justice Department doesn’t do anything, that stops being a deterrent. I just didn’t know that at the time.”

And the Justice Department still isn’t really doing anything about it. No criminal prosecutions have come about from the obvious fraudulent activities of hundreds of people up and down the chain of command. Perhaps the DOJ wasn’t prepared for Nuremburg type trial where everyone claims they were merely following orders, but that’s no excuse for failing to send a deterrent message to others who would commit these crimes in the future.subprime_steak

That September, as the market was crashing, Dimon boasted in a ball-washing Fortune article titled “Jamie Dimon’s SWAT Team” that he knew well before the meltdown that the subprime market was toast. “We concluded that underwriting standards were deteriorating across the industry.” The story tells of Dimon ordering Boester’s boss, William King, to dump the bank’s subprime holdings in October 2006. “Billy,” Dimon says, “we need to sell a lot of our positions. . . . This stuff could go up in smoke!”

In other words, two full months before the bank rammed through the dirty GreenPoint deal over Fleischmann’s objections, Chase’s CEO was aware that loans like this were too dangerous for Chase itself to own.

If investors were demanding it, he would keep selling it.

According to The New York Times, after Dimon had already offered $3 billion to settle the case and was turned down, he went to Holder’s office and upped the offer, but apparently not by enough. … Fleischmann later realized that the government wasn’t interested in having her testify against Chase in court or any other public forum. Instead, the Justice Department’s political wing, led by Holder, appeared to be using her, and her evidence, as a bargaining chip to extract more hush money from Dimon. It worked. Within weeks, Dimon had upped his offer to roughly $9 billion.

Good for Mr. Holder. He extorted Chase for another $6 billion. Congratulations!

Sure, he allowed widespread fraud to go unprosecuted, and the terms of the settlement allowed the bank to avoid any real consequences, but he probably got the most out of the bank he could without resorting to lengthy and costly prosecutions that might have failed. This is not a capitulation and whitewash by the DOJ as the article contends, but rather a recognition of the practical limitations on getting anything more out of Chase or its minions.

I agree with the popular sentiment that the banks should pay a heavy price, but I also recognize they are too big and powerful to take down. Perhaps it’s a defeatist attitude, but let’s face it: the banks won. They got bailed out, they avoided prosecution for their crimes, and they managed to reflate the housing bubble to avoid any meaningful losses.

It’s good to dream though…

What is best in life?

Crush the banks, see them driven into bankruptcy, and hear the lamentation of their stockholders.

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