When an outside analysis uncovered serious flaws with thousands of home loans, JPMorgan Chase executives found an easy fix.
Rather than disclosing the full extent of such problems as fraudulent home appraisals and overextended borrowers, the bank adjusted the critical reviews, according to documents filed earlier this week in federal court in Manhattan. As a result, the mortgages, which JPMorgan bundled into complex securities, appeared healthier, making the deals more appealing to investors.
The trove of internal emails and employee interviews, filed as part of a lawsuit by one of the investors in the securities, offers a fresh glimpse into Wall Street's mortgage machine, which churned out billions of dollars of securities that later imploded. The documents reveal that JPMorgan, as well as two firms the bank acquired during the credit crisis, Washington Mutual and Bear Stearns, flouted quality controls and ignored problems, sometimes hiding them entirely, in a quest for profit.
The lawsuit, which was filed by Dexia, a Belgian-French bank, is being closely watched on Wall Street. After suffering significant losses, Dexia sued JPMorgan and its affiliates in 2012, claiming it had been duped into buying $1.6 billion of troubled mortgage-backed securities.
The latest documents could provide a window into a $200 billion case that looms over the entire industry. In that lawsuit, the Federal Housing Finance Agency, which oversees Fannie Mae and Freddie Mac, has accused 17 banks of unloading dubious mortgage securities to the two housing giants. At least 20 of the securities are also highlighted in the Dexia case, according to an analysis of court records.
In court filings, JPMorgan has strongly denied wrongdoing and is contesting both cases in federal court. It declined to comment.
Dexia's lawsuit is part of a broad assault on Wall Street for its role in the 2008 financial crisis, as prosecutors, regulators and investors focus on mortgage-related securities. New York Attorney General Eric T. Schneiderman sued JPMorgan last year over investments created by Bear Stearns between 2005 and 2007.
Jamie Dimon, JPMorgan's chief executive, has criticized prosecutors for attacking JPMorgan because of what Bear Stearns did. Speaking at the Council on Foreign Relations in October, Dimon said the bank did the federal government "a favor" by rescuing the flailing firm in 2008.
The legal onslaught has been costly. In November, JPMorgan, the nation's largest bank, agreed to pay $296.9 million to settle claims by the Securities and Exchange Commission that Bear Stearns had misled mortgage investors by hiding some delinquent loans. JPMorgan did not admit or deny wrongdoing.
"The true price tag for the ongoing costs of the litigation is terrifying," said Christopher Whalen, a senior managing director at Tangent Capital Partners.
The Dexia lawsuit centers on complex securities created by JPMorgan, Bear Stearns and Washington Mutual during the housing boom. As profits soared, the Wall Street firms scrambled to pump out more investments, even as questions emerged about their quality.
Even when flaws were flagged, JPMorgan and the other firms overlooked the warnings.
JPMorgan routinely hired Clayton Holdings and other third-party firms to examine home loans before they were packed into investments. Combing through the mortgages, the firms searched for problems like borrowers who had vastly overstated their incomes or appraisals that inflated property values.
According to the court documents, an analysis for JPMorgan in September 2006 found that "nearly half of the sample pool" or 214 loans were "defective," meaning they did not meet the underwriting standards.
The borrowers' incomes, the firms found, were dangerously low relative to the size of their mortgages. Another troubling report in 2006 discovered that thousands of borrowers had already fallen behind on their payments.
But JPMorgan routinely dismissed critical assessments or altered them, the documents show. Certain JPMorgan employees, including the bankers who assembled the mortgages and the due diligence managers, had the power to ignore or veto bad reviews.
At Bear Stearns and Washington Mutual, employees even had the power to sanitize bad assessments.