Memo to Jamie Dimon: You Still Think Bear Stearns is Not Material??

Special thanks to Manal Mehta for his amazing notes. 

Update 1 -- Link to FHFA complaint

A couple of years ago, JPMorgan Chase CEO Jamie Dimon told investors that the acquisition of Bear, Stearns & Co. would not be material to investors.  In the years that have followed, a tiny group of analysts and managers have watched as the Bear Stearns transaction has festered into a festival of fraud.  But most supposed Sell Side analysts and Buy Side investors who pretend to follow financials still don’t seem to get the joke.

The basic problem with Bear Stearns was fraud, massive, deliberate fraud.  The firm’s activities in the mortgage securities space were so sloppy and negligent as to rise the level of legend on Wall Street.  And now even Eric Schneiderman, the do-nothing NY AG, has finally been forced to take action against JPM.

“The New York attorney general's office has hit JPMorgan Chase & Co. with a civil lawsuit, alleging that investment bank Bear Stearns — prior to its collapse and subsequent sale to JPMorgan in 2008 — perpetrated massive fraud in deals involving billions in residential mortgage-backed securities,” reports the Wall Street Journal.

Now this mess is amusing and troubling both.  It is amusing that JPM did not seem to anticipate that the unliquidated claims against Bear Stearns from creating bad residential mortgage backed securities (RMBS) would eventually come back to haunt the bank.  Dimon and his bankers thought they were so cute stuffing the New York Fed with the accumulated detritus in Bear’s mortgage conduit – what later became known as the “Maiden Lane” vehicles.  

But none of the JPM bankersters gave any thought to the real liabilities of the Bear, namely the fraudulent activities of the failed bank’s mortgage securities department.  Those of us in the business knew there was something very wrong when Bear opened a retail mortgage operation to actually make loans, an activity that was not natural for the Bear.  Disclosure: I worked for Bear twice and have some insights into the risk culture at the bank.

What is really interesting is that the legal complaint filed by Schneiderman talks about sloppy procedures for loan selection, but still does not get to the real fun, namely multiple pledges of loans for different RMBS.  And you can be sure that Schneiderman does not really want to go that far because it might force him to ask the same question about the other, far larger issuers of RMBS.  

Remember, the whole point of the Robo-signing settlement is not consumer protection, but rather fraud.  The key question: Who’s got the note?  If you don’t have to deliver the note into an RMBS trust, then the door is wide open for securities fraud. 

What is really troubling is that while Schneiderman is making a big fuss about suing JPM over the Bear Stearns RMBS, he refuses to go after Bank of America, Wells Fargo, Citi, Ally and other large banks for precisely the same type of fraud and deliberate criminal acts as were committed by Bear Stearns.  The degree of negligence and stupidity displayed at Bear Stearns may have been more egregious than that at say Countrywide, but only in degree.  

Once again it is shown that the politicians like Schneiderman, who have aspirations for higher office, have no problem making an example of a small firm, but will never move directly against the top four banks for their own grotesque errors and omissions.  Schneiderman has been dragging his feet with respect to Countrywide  and Bank of New York for years, yet suddenly he has time to sue JPM over Bear Stearns?  What’s wrong with this picture?  

Keep in mind that neither JPM nor BAC have even begun to take sufficient reserves to cover a settlement of the claims facing both firms with respect to their RMBS.  BAC became the owner of the Countrywide mess by acquiring that firm w/o a bankruptcy. Likewise JPM bought Bear Stearns without a bankruptcy.  

Notice that you never hear anything about claims against Lehman Brothers or WaMu because most of these claims died in bankruptcy.  But, to add another funny, JPM also has liability due to the WaMu covered bonds that were conveyed by the FDIC’s receivership after the takeover.

So what happens with JPM and Bear?  One word: rescission.  My guess is that the fraud perpetrated by Bear Stearns in creating these rancid securities will eventually force JPM to repurchase some of the bonds from investors.  That is tens or even hundreds of billions of dollars of face amount of bad securities.  

So, Jamie, you still think that Bear Stearns is not material to JPM investors?   In case you did not guess, that is going to be my question for Dimon on the JPM analyst call.