J.P. Morgan face record-breaking fine

Bank tentatively agrees to settlement with US Justice Department, reports Craig O'Callaghan

n the largest settlement every paid by a US company, J.P. Morgan will pay a $13 billion (£8 billion) fine for their handling of mortgage-backed securities in the build-up to the financial crisis. The figure has raised eyebrows around the world, with some claiming the punishment is unfair while others have questioned whether it goes far enough.

What are mortgage-backed securities?

Mortgage-backed securities (MBS) were a special type of financial product created by investment banks that combined a variety of investments. At the heart of this combination were mortgages, supposedly reliable, fixed assets which carried minimal risk of not being repaid.

Although MBSs were widely used across the industry, J.P. Morgan incurred the wrath of the US authorities by knowingly selling MBSs based on high-risk mortgages which were likely to default. After the housing bubble burst, banks suddenly realised these securities were worth a fraction of their official value which had a knock-on effect leading to several banks collapsing and requiring government bailouts.

Why $13 billion?

The settlement figure may seem arbitrary, but it's based on a series of smaller fines. $4 billion is to settle a lawsuit from a federal housing regulator accusing the bank of selling shoddy mortgage securities to Fannie Mae and Freddie Mac, the government-owned mortgage finance companies. Another $4 billion has been set aside to provide financial relief for struggling homeowners who have suffered due to the bank's mortgage practices.

While these figures are pretty eye-watering, J.P. Morgan's business is unlikely to be affected: since 2010 the bank has set aside $28 billion to cover litigation expenses.

Why do some feel the fine was unfair?

A significant proportion of the dodgy MBSs are supposedly not the fault of J.P. Morgan but were inherited by the bank when they acquired Bear Stearns and Washington Mutual during the financial crisis, purchases that were actively encouraged by the Federal bank in order to stave off a wider collapse. Defenders of J.P. Morgan feel the bank has been unfairly punished for crimes it didn't commit.

What long-term damage will the fine do?

In truth, very little. Since the fine was announced, J.P. Morgan's share price has held firm, even climbing to a 52 week high at one stage, suggesting investors aren't concerned about the fine doing any lasting damage. This is unsurprising given last year saw the bank generate more than $21 billion in net profit, suggesting $13 billion won't be too devastating a loss.

One of the problems with large fines such as this is that it ultimately punishes shareholders more than it punishes those who are actually guilty of creating and encouraging faulty MBSs. As John Cassidy wrote in the New Yorker, "we seem to have stumbled into a new form of corporate regulation, in which nobody in the executive suite is held personally accountable for wrongdoing lower down the ranks, but the corporation and its stockholders are periodically socked with huge fines for past abuses."

It remains to be seen whether this heavy fine will be a sufficient deterrent to prevent J.P. Morgan and other investment banks engaging in dangerous activities in the future. Given the relative ease with which J.P. Morgan have survived this storm, it would hardly be surprising if it fails.

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