Tuesday, October 22, 2013

Where to Point the Finger: JP Morgan

Where to Point the Finger: JP Morgan

JP Morgan is in settlement talks with the US Department of Justice to settle a host of civil charges related to its mortgage lending business.  Apparently the settlement will come to about $13 billion.  A portion of the settlement is designed to compensate homeowners, and another component is supposed to reimburse entities that purchased mortgages from the bank.  Only about $3 billion is considered a penalty.  From JP Morgan’s perspective, the overall settlement would represent 6% of the company’s value or 6 months of the company’s net profits.  Wall Street is claiming that JP Morgan is being unfairly targeted because this settlement is largely the result of actions taken by two acquired banks, Bear Stearns and Washington Mutual.  JP Morgan acquired both the assets and liabilities of these institutions, so it is hard to feel sorry for them.

This settlement is stacked on top of   JP Morgan has settled the “whale trade” for $900 million, credit card improprieties for nearly $400 million, energy market manipulation for just over $400 million, and improper foreclosure practices for $1.96 billion.  And these are just the settlements this year.  The bank is also involved in the LIBOR manipulation case.
Investment Model (1999)
a host of other matters, some settled and other pending, that touch a wide range of the bank’s business practices.

Let’s examine how these settlements affect the three constituents who might bear the burden and responsibility of the fines and settlements: management, shareholders and money managers. 

We’ll begin with Mr. Dimon and his management team.  While JP Morgan’s chairman deserves credit for assembling the largest bank, he has also been at the helm during all these transgressions and acquisitions.  By my estimate, Mr. Dimon has received about $273 million in total compensation between 2000 and 2012.  In years like 2009, he received a mere $1.3 million, while 2006 netted him a cool $39.1 million.  According to various estimates, Mr. Dimon is worth over $400 million.

Even if Mr. Dimon were forced to resign, the only damage he might incur would be to his ego or reputation.  His status as a fabulously rich person has never been in doubt.  Meanwhile, a few executives have resigned, most notably Ina Drew, the bank’s Chief Investment Officer.  A couple of traders have been indicted.  However, most of the executives have not faced any serious consequences.

We’re the ones taking the hit.  All of us who own mutual funds or have pensions invested in the stock will take the hit.  JP Morgan is very widely held, so the pain of these settlements will reach most people who have equity investments.  This is money that could have been used to build the value of our investments or paid to us as dividends.  Even if you are not an investor, you’ll take a hit as a taxpayer.  Most of these settlements are tax deductible, so the bank’s tax liability will diminish, and we will have to pick up the difference.

Our money managers have poorly represented us.  They have been wined and dined by JP Morgan, and their portfolio managers and analysts have fawned over Mr. Dimon and his management team.  For the most part our money managers have ratified every dollar of compensation awarded to Mr. Dimon.  Who are these asset managers?  The five largest money management firms represent a significant part of the bank’s ownership.   Vanguard, State Street, Blackrock, Fidelity, and Wellington Management collectively own over 17% of the company, and the next five firms own another 6% of JP Morgan.  By my rough estimate, the top 10 money managers alone are paid about $100 million in fees to own the stock.  While their fees might be diminished a bit if the price of the stock fell due to the settlement, they are extraordinarily well compensated for simply owning and supporting JP Morgan.  As the Justice Department settles with JP Morgan, the money management industry faces virtually no financial or reputational risk for having backed incumbent management.  Of course, these are the same money managers who back AIG, Lehman, Bank of America, Countrywide, Fannie Mae, Freddie Mac, Bear Stearns, Washington Mutual, et. al.

You shouldn’t conclude that JP Morgan is being treated unfairly.  Wall Street loves to feel sorry for itself.  You should be upset that Mr. Dimon, his team, and the executives at the institutions JP Morgan have avoided culpability. And you should reserve a great deal of your anger at your money managers.  They haven’t been doing their job at all.

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