thanks to an accounting rule that lets the second-biggest U.S. bank transform bad loans it purchased from Washington Mutual Inc. into income

TO BE NOTED: From Bloomberg:

"JPMorgan’s WaMu Windfall Turns Bad Loans Into Income (Update2)

By Ari Levy and Elizabeth Hester

May 26 (Bloomberg) -- JPMorgan Chase & Co. stands to reap a $29 billion windfall thanks to an accounting rule that lets the second-biggest U.S. bank transform bad loans it purchased from Washington Mutual Inc. into income.

Wells Fargo & Co., Bank of America Corp. and PNC Financial Services Group Inc. are also poised to benefit from taking over home lenders Wachovia Corp., Countrywide Financial Corp. and National City Corp., regulatory filings show. The deals provide a combined $56 billion in so-called accretable yield, the difference between the value of the loans on the banks’ balance sheets and the cash flow they’re expected to produce.

Faced with the highest U.S. unemployment in 25 years and a surging foreclosure rate, the lenders are seizing on a four- year-old rule aimed at standardizing how they book acquired loans that have deteriorated in credit quality. By applying the measure to mortgages and commercial loans that lost value during the worst financial crisis since the Great Depression, the banks will wring revenue from the wreckage, said Robert Willens, a former Lehman Brothers Holdings Inc. executive who runs a tax and accounting consulting firm in New York.

“It will benefit these guys dramatically,” Willens said. “There’s a great chance they’ll be able to record very substantial gains going forward.”

JPMorgan rose $2.13, or 6.2 percent, to $36.54 at 4 p.m. in New York Stock Exchange composite trading. Wells Fargo gained 1.3 percent to $25.65 and PNC Financial climbed 5 percent to $43.25. Bank of America fell 9 cents to $10.98.

Purchase Accounting

When JPMorgan bought WaMu out of receivership last September for $1.9 billion, the New York-based bank used purchase accounting, which allows it to record impaired loans at fair value, marking down $118.2 billion of assets by 25 percent. Now, as borrowers pay their debts, the bank says it may gain $29.1 billion over the life of the loans in income before taxes and expenses.

The purchase-accounting rule, known as Statement of Position 03-3, provides banks with an incentive to mark down loans they acquire as aggressively as possible, said Gerard Cassidy, an analyst at RBC Capital Markets in Portland, Maine.

“One of the beauties of purchase accounting is after you mark down your assets, you accrete them back in,” Cassidy said. “Those transactions should be favorable over the long run.”

JPMorgan bought WaMu’s deposits and loans after regulators seized the Seattle-based thrift in the biggest bank failure in U.S. history. JPMorgan took a $29.4 billion writedown on WaMu’s holdings, mostly for option adjustable-rate mortgages and home- equity loans.

‘Price Judgment’

“We marked the portfolio based on a number of factors, including housing-price judgment at the time,” said JPMorgan spokesman Thomas Kelly. “The accretion is driven by prevailing interest rates.”

JPMorgan said first-quarter gains from the WaMu loans resulted in $1.26 billion in interest income and left the bank with an accretable-yield balance that could result in additional income of $29.1 billion.

The difference in accretable yield from bank to bank is due to the amount of impaired loans, the credit quality of the acquired assets and the state of the economy when the deals were completed. Rising and falling interest rates also affect accretable yield for portfolios with adjustable-rate loans.

It’s difficult to gauge how much the yield will add to total revenue because banks don’t disclose the expenses that chisel away at the figure. The income is also booked over the life of the loans, rather than in a lump sum, and banks don’t spell out how long that is, Willens said.

Wachovia ARMs

Wells Fargo arranged the $12.7 billion purchase of Wachovia in October, as the Charlotte, North Carolina-based bank was sinking from $122 billion in option ARMs. As of March 31, San Francisco-based Wells Fargo had marked down $93 billion of impaired Wachovia loans by 37 percent. The expected cash flow was $70.3 billion.

The Wachovia loans added $561 million to the bank’s first- quarter interest income, leaving Wells Fargo with a remaining accretable yield of almost $10 billion.

Government efforts to reduce mortgage rates and stabilize the housing market may make it easier for borrowers to repay loans and for banks to realize the accretable yield on their books. With mortgage rates below 5 percent, originations surged 71 percent in the first quarter from the fourth, a pace that may accelerate during 2009, said Guy Cecala, publisher of Inside Mortgage Finance in Bethesda, Maryland.

Recapturing Writedowns

Wells Fargo, the biggest U.S. mortgage originator, doubled home loans in the first quarter from the previous three months, in part through refinancing Wachovia loans.

“To the extent that the customers’ experience is better or we can modify the loans, and the loans become more current, that could help recapture some of the writedown,” Wells Fargo Chief Financial Officer Howard Atkins said in an April 22 interview.

Banks still face the risk that defaults may exceed expectations and lead to further writedowns on their purchased loans. Foreclosure filings in the U.S. rose to a record for the second straight month in April, climbing 32 percent from a year earlier to more than 342,000, data compiled by Irvine, California-based RealtyTrac Inc. show.

The companies bought by Wells Fargo, JPMorgan, PNC and Bank of America were among the biggest lenders in states with the highest foreclosure rates, including California, Florida and Ohio. Housing prices tumbled the most on record in the first quarter, leaving an increasing number of borrowers owing more in mortgage payments than their homes are worth, according to Zillow.com, an online property data company.

Accretable Yield

“We’ve still got a lot of downside to work through this year and probably through at least part of next,” said William Schwartz, a credit analyst at DBRS Inc. in New York. “If I were them, I wouldn’t be claiming any victory yet.”

PNC closed its $3.9 billion acquisition of National City on Dec. 31, after the Cleveland-based bank racked up more than $4 billion in losses tied to subprime loans. PNC, based in Pittsburgh, marked down $19.3 billion of impaired loans by 38 percent, or $7.4 billion, and said it expected to recoup half of the writedown. After gaining $213 million in interest income in the first quarter and making some adjustments, the company has an accretable-yield balance of $2.9 billion.

“We’re just being prudent,” PNC Chief Financial Officer Richard Johnson said in a May 19 interview.

‘Huge Cushion’

Johnson said he expects the entire accretable yield to result in earnings. The company has taken into “consideration everything that can go wrong with the economy,” he said.

Bank of America, the biggest U.S. bank by assets, has potential purchase-accounting income of $14.1 billion, including $627 million of gains from Merrill Lynch & Co. and the rest from Countrywide. Bank of America bought subprime lender Countrywide in July, two months before the financial crisis forced Lehman Brothers into bankruptcy and WaMu into receivership.

As market losses deepened, Bank of America had to reduce the returns it expected the impaired loans to produce from an original estimate of $19.6 billion.

“The Countrywide marks in hindsight weren’t nearly as aggressive,” said Jason Goldberg, an analyst at Barclays Capital in New York, who has “equal weight” investment ratings on Bank of America and PNC and “overweight” recommendations for Wells Fargo and JPMorgan.

Bank of America spokesman Jerry Dubrowski declined to comment.

The discounted assets purchased by JPMorgan and Wells Fargo make the stocks more attractive because they will spur an acceleration in profit growth, said Chris Armbruster, an analyst at Al Frank Asset Management Inc. in Laguna Beach, California.

“There’s definitely going to be some marks that were taken that were too extreme,” said Armbruster, whose firm oversees about $375 million. “It gives them a huge cushion or buffer to smooth out earnings.”

To contact the reporters on this story: Ari Levy in San Francisco at alevy5@bloomberg.net; Elizabeth Hester in New York at ehester@bloomberg.net."

From Calculated Risk:

"Revisiting the JPMorgan / WaMu Acquisition

by CalculatedRisk on 5/26/2009 03:01:00 PM

From Bloomberg: JPMorgan’s WaMu Windfall Turns Bad Loans Into Income (ht Mike in Long Island)

When JPMorgan bought WaMu out of receivership last September for $1.9 billion, the New York-based bank used purchase accounting, which allows it to record impaired loans at fair value, marking down $118.2 billion of assets by 25 percent. Now, as borrowers pay their debts, the bank says it may gain $29.1 billion over the life of the loans in pretax income before taxes and expenses.
...
JPMorgan took a $29.4-billion writedown on WaMu’s holdings, mostly for option adjustable-rate mortgages (ARMs) and home- equity loans.

“We marked the portfolio based on a number of factors, including housing-price judgment at the time,” said JPMorgan spokesman Thomas Kelly. “The accretion is driven by prevailing interest rates.”

JPMorgan said first-quarter gains from the WaMu loans resulted in $1.26 billion in interest income and left the bank with an accretable-yield balance that could result in additional income of $29.1 billion.
emphasis added

Let's review the JPMorgan's "judgment at the time" of the acquisition. First, here is the presentation material from last September.

Click on graph for larger image in new window.

Here are the bad asset details. Also see page 16 for assumptions.

This shows the $50 billion in Option ARMs, $59 billion in home equity loans, and $15 billion in subprime loans on WaMu's books at the time of the acquisition. Plus another $15 billion in other mortgage loans.

And the second excerpt shows JPMorgan's economic judgment at the time of the acquisition.

JPMorgan's marks assumed that the unemployment rate would peak at 7.0% and house prices would decline about 25% peak-to-trough.

Note that the projected losses at the bottom of the table are from Dec 2007. As the article noted, in September 2008, JPMorgan took a writedown of close to $30 billion mostly for Option ARMs and home equity loans.

This graphic shows the unemployment rate when the deal was announced (in purple), the three scenarios JPMorgan presented (the writedowns were based on unemployment peaking at 7%) and the current unemployment rate (8.9%).

Clearly JPMorgan underestimated the rise in unemployment, and this suggests the $29.4 billion writedown was too small.

And the last graph compares JPMorgan's forecast for additional house price declines and the actual declines using the Case-Shiller national home price index and the Case-Shiller composite 20 index.

House prices have declined about 32.2% peak-to-trough according to Case-Shiller - nearing JPMorgan's 37% projection for a severe recession.

This shows JPMorgan underestimated additional house price declines when they acquired WaMu. Instead of $36 billion in additional losses since December 31, 2007 (and the $29.4 billion writedown), this suggests JPMorgan expects losses will be $54 billion or more.

Posted by CalculatedRisk on 5/26/2009 03:01:00 PM "

To us, that week, it looked very much like a run on the entire financial system

TO BE NOTED:

Sunday, May 17, 2009

How TARP Began: An Exclusive Inside View

May 14, 2009 04:01 PM ET | Rick Newman | Permanent Link | Print

When it first came into existence last September, TARP—the troubled assets relief program—sounded like just another ungainly government acronym. But since then, it has become an integral—and controversial—part of America's recession economy.

TARP's chief architect was Henry "Hank" Paulson, President Bush's treasury secretary, who led the financial rescue along with Federal Reserve Chairman Ben Bernanke and New York Fed Chairman Tim Geithner, who's now Paulson's replacement at treasury. Their initial plan was to use the $700 billion in TARP funding approved by Congress last October to purge financial firms of their so-called toxic assets.

[See why the banks still aren't fixed.]

But TARP morphed into an über-bailout that included direct cash injections into banks, the auto rescue, the AIG intervention, and other government efforts to revive the economy. If it sounds like a trial-and-error experiment, well, that's how it felt to the policymakers who designed it, too. "When we looked for easy solutions, we kept coming up empty," says David Nason, who was a senior Treasury Department official during the Bush administration. "Hank used to say all the time, 'We're going to have to do this with duct tape and fishing wire.' "

Nason and some of his Treasury colleagues did much of the jury-rigging, running doomsday scenarios, negotiating emergency deals with banks, wooing incredulous members of Congress, and devising ways to deal with problems once considered unthinkable. Frustrated Treasury Department officials, for instance, foresaw much of the carnage but found themselves poorly equipped to stop it. Anxious finance ministers from around the world began calling Treasury last summer to find out what the government planned to do about the developing crisis. The most tense moment may have been the September failure of Lehman Brothers, which occurred with alarming speed after British financial regulators scotched a takeover bid by the British bank Barclays.

[See 6 surprises from the recent bank stress tests.]

Nason and two other former Treasury officials, Philip Swagel and Kevin Fromer, spoke recently at a panel discussion sponsored by the Milken Institute. Their remarks form one of the most thorough accounts to date of how the government struggled to contain the worst financial crisis since the Great Depression. (See a video of the full discussion, which I moderated.) Here's a condensed version of their remarks:

David Nason, former assistant treasury secretary for financial institutions: The first inflection point was March 16, 2008, which was the acquisition date by JPMorgan Chase of Bear Stearns. The sheer time it took for this institution to go from viable to nonviable was breathtaking. Just two days before, the regulator [the Securities and Exchange Commission] had said Bear had adequate liquidity of $8 billion. This is an important inflection point because it was the first time the government had stood up and said we are going to support nonbanking institutions. We knew at that point the times had changed. We knew the policy ramifications were going to be very difficult and far reaching.

[See 5 signs the bailouts are getting better.]

We worried most significantly about the consequences of other similarly situated firms. It was a very trying and stressful time because when we looked for easy solutions, we kept coming up empty. The government did not have a ready-access pool of money to support or manage the resolution of financial institutions. The political climate was very challenging—at the time, people saw this as a bailout for fat cats on Wall Street. And there was some jurisdictional squabbling in Washington.

Philip Swagel, former assistant treasury secretary for economic policy: Right after Bear failed, the economy looked like it was actually in pretty good shape considering the problems in housing and the financial sector. Overall growth was positive, driven especially by exports. In the wake of Bear's failure, we looked at options, including many things that are now familiar: buying assets, insuring assets, buying pieces of pieces of institutions, in other words injecting capital, and a massive bailout from the bottom from refinancing every troubled homeowner. And we said those are all things you could write down, but back then, you had rebate checks that had been enacted but weren't yet going out, and we had positive growth. It would have been hard to imagine getting the authority to do those things or the approval from Congress for a contingency fund in case things got worse.

Nason: The next inflection point was July 2008. The government was worried about the big investment banks, CDS [credit-default-swap] spreads were blowing out, we were also worried about Fannie Mae and Freddie Mac. These were some of the most leveraged institutions on Earth. Together, they had over $5 trillion in exposure if you consider the guarantee obligations that they had. Match that against about $60 billion in capital. We were also concerned that the housing correction was turning out to be significantly worse than the GSEs [government-sponsored enterprises, such as Fannie and Freddie] expected. We were very concerned that the GSEs were being overly optimistic about their ability to manage risk and withstand future losses.

[See the best and worst bailed-out banks.]

The GSE equity prices were getting punished during this time. More important to us, however, was the debt market. It was very clear to us there's no way the U.S. financial system is going to allow a firm the size of Fannie Mae to collapse( NB DON ). We were very worried about the trillions in debt they had outstanding, and what it would do to confidence if we let that debt go.

At this time, the Treasury was getting calls from finance ministers' offices from different parts of the world inquiring, "What is the government's relationship with Fannie Mae and Freddie Mac?" It's odd, but this appeared to be the first time that people were focusing on the fact that these are quasi-governmental institutions.

During this time period, the home loan banks, another GSE with similar exposure to the housing market, decided to postpone an auction. Every auction was something that we focused on and were worried about.

[See the banks most likely to pay back their bailout funds.]

We made the decision based on this set of circumstances that we had to support the GSEs. How were we going to do that? What did we have in our toolbox? Essentially nothing. We had about $2 billion of backup credit support for the GSEs. For $1.4 trillion organizations. This was clearly not enough to support these institutions in any real way. And we had no ability to provide any kind of equity support at all. So we decided we had to go up to Congress, bite the bullet, and ask for authority to backstop these institutions.

On July 30, 2008, the president signed a bill into law to provide equity support to these institutions. And we had the ability to support their debt up to the federal debt limit.

We made the judgment not to request the authority to nationalize the GSEs. It would have muddied the political discussion. I'm not sure we would have gotten the authority, and at this time, there wasn't a pressing need to do so. There's a long, tortured story about how the GSEs and Washington interface. But we wanted to have broad authority to support the GSEs and prevent their collapse.

[See why the auto bailout is a good model for other struggling firms.]

The entire month of September was an inflection point under my definition. But the first inflection point associated with September is Sept. 7, 2008, when the GSEs were forced into conservatorship. That came after regulators determined that they were drastically undercapitalized.

Two days later, AIG's stock fell 19 percent. Lehman's discussions to sell itself to the Korean Development Bank failed. The next day, Lehman put itself on the market for sale, with no clear takers. After some very tense discussions about whether there would be a purchaser, like JPMorgan was for Bear Stearns, we were very distressed to know that there were no takers.

So from the 10th to the 14th, the Federal Reserve, with the Treasury's support, decided to flush the system with liquidity. The Federal Reserve expanded the level of collateral the primary dealer credit facility would take, they increased the collateral that the term securities lending facility could take, and they increased the ability of banks to support nonbanking institutions. The government was putting "foam on the runway" to try to deal with what we were afraid of, which was how the market would react to a Lehman Brothers bankruptcy.

The next day, Lehman Brothers filed for bankruptcy.

The question is: Did we let Lehman Brothers fail? That assumes it was a choice that we made. The simple truth is that the government was presented with an institution with a $600 billion balance sheet, with enormous leverage. Confidence in the institution was virtually nonexistent. The only way to stabilize a firm under these circumstances is to stop a run on the institution, stop counterparties from claiming their debts should immediately come due. That was manageable in the Bear Stearns situation because someone was willing to guarantee all or most of those liabilities.

[See how bailouts can butcher capitalism.]

The public posture was that government support would not be available. But there wasn't a single credible buyer at the table who was turned away by us.

So when people ask, "Why did you let Lehman Brothers fail?" I ask, "What is the deal that the government turned down that would have prevented Lehman's failure?" If there's not someone willing to take on a balance sheet as large as that of Lehman Brothers, what is the government to do? The government has a few options: We have a lending facility at the Fed, you could provide a loan to them secured against collateral, or you could guarantee all their liabilities. That might have been the right decision, but we had no authority to do that before TARP.( NB DON )

Looking back, if we could have plugged some of the holes in our authorities, maybe this could have been done differently. I don't think we would have gotten those authorities if we had asked for them before September.

[See why the feds rescue banks, not homeowners.]

Of course, things continued to be unpredictable. We didn't predict that the U.K. bankruptcy process would essentially destroy all confidence in that funding model and that business model. And we didn't expect that the commercial paper market would essentially shut down because Lehman Brothers' commercial paper was impaired. Those two markets were the transmission vehicles that killed confidence, which we didn't expect.

That same day as Lehman, Bank of America acquired Merrill Lynch. We didn't have a second to catch our breath. The day after the Lehman bankruptcy, AIG got a $50 billion loan from the Federal Reserve. There was no significant discussion over whether the Federal Reserve was going to provide backup facilities to AIG because of two distinguishing characteristics: One, they were huge. They were global. They were bigger than Lehman Brothers. But the more important distinction is that the Fed is in the business of providing loans when it is "secured to its satisfaction." And AIG had the benefit of having solvent, highly regulated, very valuable insurance subsidiaries to which the Federal Reserve felt comfortable extending its loan facilities.

[See more companies likely to fail this year.]

After that we get to Sept. 17 2008, which was essentially the creation of the TARP concept. It was at that point that there was a meeting of the minds between Paulson, Bernanke, and Geithner that enough is enough, we're going to break the back of this crisis, and we're tired of not having the tools to deal with this crisis. And the judgment was made that we were going to ask for broad authority from Congress.

At that point, it was essentially 24-hour duty at the Treasury Department. Some people slept there.

Kevin Fromer, former assistant treasury secretary for legislative a ffairs: For context, this was a program about the size of the entire federal operating budget on an annual basis. Congress usually works through that process for 10 or 15 months, just to keep the lights on. We were asking Congress for $700 billion in basically a week or two. In the context of a national election. An election year is typically not the year to do big things.

We had one week left in the legislative calendar. It was not possible to do it in a week. I wasn't sure it was possible to do it at all. We needed to get somewhere fast, so we sent up the infamous three-page bill, which was draft legislative text the committees needed to start the discussions.

[See why the markets hate the idea of bank nationalization.]

Swagel: It was very difficult to say, if this shock happens, you will get this economic effect. In September, the nation as a whole didn't understand that what was happening in the credit markets would matter to them. There was this sort of Wall Street-Main Street divide. It was hard to explain to people why this mattered.

The week of Lehman and AIG, there was a panicked flight from mutual funds, and that led to a lockup in commercial paper. In our view, that was really the key, the CP market breaking down. That had a direct link to investment. Businesses use that to fund their daily operations. That would lead to a direct plunge in business spending, and that's exactly what we've seen over the last two quarters. A very sharp decline in business investment.

The one-month Libor [London interbank offered rate] spread is a measure of stress in bank lending. It's really, do you trust a bank to hold your money for a month. After that week, the stresses in the bank funding markets were huge. To us, that week, it looked very much like a run on the entire financial system. ( NB DON )

Nason: We were afraid of a complete and utter collapse of the global financial system.( NB DON )

Swagel: Imagine if the Fortune 500, blue-chip companies, can't buy paper clips or meet their payroll. All the things these firms rely on money-market funds and commercial paper for. And it goes downhill from there. It starts with the big firms and then every firm in the nation.

Fromer: This was an extremely difficult communications challenge. It made it enormously difficult to sell the package to Congress and for them to sell it back home. They were angry when they came back from home after the election. They had seen the amount of money they were being asked to put into institutions, getting anecdotal information from small businesses and lending institutions, and the picture was, we've invested significantly in these institutions, and we're not seeing credit flow to consumers and small businesses.

The markets were volatile for quite some time, and people became desensitized to volatility in the markets. What people didn't understand, which was quite reasonable, was the credit markets, how credit is provided in this country. That's not a criticism; it's arcane to anybody without a certain educational background. It's an almost-impossible-to-explain set of circumstances.

Nason: People were getting used to seeing the stock market go up and down. We were trying to explain, "What's happening in the equity market is not really what we're worried about. We're worried about some other market that you've never seen and aren't familiar with," and people look at you like you're insane because you're asking for $700 billion and you can't provide anything besides a chart to show why it's important.

[Here's the chart, which shows how rapidly widening credit spreads reflect a seizure in the credit markets.]

People could appreciate the money-market mutual funds situation. There is $3.3 trillion of money invested in money-market mutual funds. A panic in these funds helped in terms of selling the importance of our message. And the commercial-paper market stress was important in communicating this as well. If that market collapses, you could have huge employers saying, I'm going to start laying people off. I'm going to start shutting plants down, I'm going to start defaulting on my bonds, and that's going to trigger bankruptcy( NB DON ). Those are the kinds of things you had to say, in the doomsday scenario, to convince people that this was critical to the system.

After [the first TARP vote] failed in the House [on September 29], then the equity markets finally responded. [The Dow Jones industrial average plunged 778 points.]

Fromer: It was clearly a response that forced a number of people to say, "OK, we get it now."

Swagel: Even after the legislation passed, stresses in bank funding still got worse. So we got what we needed; we were thinking about buying assets, but we needed to think more broadly.

Nason: There were two purposes at the time. This is a critically important point and something the current administration is suffering under. The dual purposes were financial system stability and provision of credit to the economy. People are not focused at all on the fact that the former is the primary reason we went up and asked for emergency authority. To derail a total breakdown of the financial markets and the global financial system. And we believe and hope that the confluence of programs put into place in a very short period of time actually did that.

The second part of it is, getting credit flowing into the economy. People seem to only focus on, "Why isn't this money being put into the economy?" That's important, of course, but you have to remember a significant portion of this money was there to be a buffer against future losses.

Swagel: To me, the stabilization of the financial markets is the salient accomplishment of the TARP and the actions of the Treasury in the fall. The normal playbook for dealing with a bank crisis is first, winnow out the banking sector so the zombie institutions don't clog up the credit channels and divert resources. As a society, I'm not sure we're going to do that. Next is stabilize, inject capital into the firms that are left so they're still viable. And No. 3 is do something about the balance sheets. Give certainty about the performance of the assets and the viability of the firms. I think we did No. 2, we stabilized the system. No. 3 is still the ongoing challenge.

Nason: The reason the TARP morphed from asset purchases to injecting capital is really quite practical. Asset purchases were taking longer than we had hoped, and it was more complicated with the vendors. Also, we needed to be in lockstep with our brethren around the world. The U.K., France, and Germany were prepared to guarantee the liabilities of the banking sector and were going to deploy capital into their banks.

Fromer: The folks in place right now clearly have the advantage of looking back at what we did and the conditions that existed when we did it. They're benefiting from experience. A number of them were part of the process going back to last summer.

Swagel: The job of the TARP has not been done, but the first step is done. In terms of the larger picture of what matters to families, we're still pretty far away from getting back to normal.

Nason: There are still valuation problems with a lot of the assets on bank balance sheets. Then we still have to deal with inevitable credit contraction.

Fromer: It's not conceivable to me that there's a TARP II. It's going to take time for these programs to stand up and operate and invoke full participation from all quarters. Given dynamics right now, I think it's unlikely there will be another TARP."

ensure that MBIA pays valid claims on insurance it issued on defaulting bonds

TO BE NOTED: From Reuters:

"Banks sue MBIA over $5 billion restructuring

Wed May 13, 2009 9:53pm EDT

NEW YORK (Reuters) - A group of major banks including Citigroup Inc, JPMorgan Chase & Co and Barclays Plc has sued MBIA Inc, charging that the bond insurer illegally restructured its operations by moving $5 billion of assets and leaving a key unit effectively insolvent.

The group of around 20 financial institutions and affiliates are seeking to ensure that MBIA pays valid claims on insurance it issued on defaulting bonds, but did not put a value on such claims.

MBIA, along with rival bond insurer Ambac Financial Group Inc, suffered huge losses in the recent financial turmoil as they were hit by claims on insurance policies they issued on repackaged debt, which turned out to be more risky than they assumed.

A spokesman for MBIA, which reported a profit of $697 million last quarter, declined comment on the lawsuit, which was filed on Wednesday in New York State Supreme Court.

The company's shares fell 9 percent in after-hours trading to $5.16, after falling more than 7 percent in regular trading on the New York Stock Exchange.

In the suit, the banks charge that MBIA acted illegally when it created a new municipal-bond insurance business earlier this year, making it free of its contractual obligations to policyholders.

As a result of moving $5 billion in assets, the banks said in their court documents, that MBIA Insurance -- the operating unit which pays claims -- is now "effectively insolvent" with no means of paying claims.

The banks claim that MBIA could instead have used its own cash to strengthen the balance sheet of MBIA Insurance, but it chose to spend more than $900 million repurchasing its own stock and debt and lending money to its asset management business. As a result, the suit claims MBIA executives will benefit while policyholders are left facing losses.

Other major banks party to the suit include units of: ABN Amro, BNP Paribas; HSBC, Bank of America Corp, Morgan Stanley, Royal Bank of Canada, Societe Generale, UBS AG and Wachovia Bank.

(Reporting by Bill Rigby; editing by Carol Bishopric)"

Prosecutors are trying to determine whether it conspired with financial advisers to overcharge customers.

TO BE NOTED: From Bloomberg:

"JPMorgan Faces Charges Over Derivatives Sales to Alabama County

Share | Email | Print | A A A

By Martin Z. Braun and William Selway

May 8 (Bloomberg) -- JPMorgan Chase & Co. said yesterday it’s facing charges that it violated federal securities laws over bond and interest-rate swap sales that helped push Alabama’s most populous county to the brink of bankruptcy.

Potential action by the U.S. Securities and Exchange Commission comes as Birmingham, Alabama’s mayor awaits trial this summer on bribery and money laundering charges in connection with the deals while he was president of the Jefferson County Commission.

At least seven former JPMorgan bankers are under scrutiny in a Justice Department criminal antitrust investigation of the sale of unregulated derivatives to local governments across the U.S., federal regulatory records show.

“The bigger the amount of money, the more temptation there is for corruption,” said Christopher “Kit” Taylor, executive director of the Municipal Securities Rulemaking Board from 1978 to 2007.

JPMorgan may be the first bank to be challenged by federal regulators for the practice of selling municipalities interest- rate swaps, a technique marketed as a way for cash-strapped cities and towns to save on their financing. The transactions have also provided Wall Street banks with fees 10 times larger than what they get for municipal bond sales.

The complex contracts, which local officials across the U.S. have said they don’t understand, backfired last year as fallout from the global credit crunch caused municipal borrowing costs to rise more than fourfold.

Soaring Costs

No location has been hit harder by its derivative deals than Jefferson County, which for more than a year has been unable to pay the soaring cost of its sewer bond deals with JPMorgan in 2002 and 2003.

The SEC’s move toward sanctioning JPMorgan comes four years after Bloomberg News reported that the New York-based bank overcharged the county by at least $45 million on derivative contracts. All of the transactions were tied to debt that financed construction of the county’s sewers.

Those public financings have pushed the county toward insolvency, threatening it with bankruptcy. They’re also threatening to cost local residents, as the rate for their sewer bills has more than tripled to cover borrowing costs.

JPMorgan spokesman Brian Marchiony declined to comment. The bank said in a regulatory filing yesterday that it is “engaged in discussions” with the SEC to reach a resolution before the agency files a civil complaint.

JPMorgan Closes Unit

JPMorgan said in September that it decided to close the unit that sold interest-rate swaps to government borrowers.

SEC spokesman John Heine declined to comment and Jefferson County Commissioner Jim Carns said he was unaware of any SEC moves against JPMorgan.

JPMorgan’s role in selling interest-rate derivatives to cities and towns has led to a nationwide federal investigation of the bank. Prosecutors are trying to determine whether it conspired with financial advisers to overcharge customers.

The bank sold swap contracts to school districts and other borrowers desperate to raise cash. In Butler, Pennsylvania, JPMorgan convinced a cash-strapped school district in 2003 to sell it an option on an interest-rate swap, a so-called swaption, for $730,000.

The district later said it had been duped by the bank. Last year it repaid JPMorgan seven times what it had received to get out of the deal. Erie, Pennsylvania’s school district sold a similar contract to the bank in 2003.

‘Sucker Punch’

“You have severe building needs, you have serious academic needs,” James Barker, superintendent of the Erie school district, said in a Nov. 2007 interview. “It’s very hard to ignore the fact that the bank says it will give you cash.”

Three years after JPMorgan paid the Erie schools $750,000, interest rates went the wrong way and the district paid the bank $2.9 million to cancel the contract.

“That was like a sucker punch,” Barker said. “It’s not about the district and the superintendent. It’s about resources being sucked out of the classroom. If it’s happening here, it’s happening in other places.”

In 2002 and 2003, relying on JPMorgan’s advice, Jefferson County refinanced $3 billion of sewer bonds with floating-rate debt and interest-rate swaps, public records show.

The bank had told county commissioners that the deals would cut the locality’s borrowing costs. In a swap, parties agree to exchange interest payments based on an underlying bond. The two sides pay each other amounts based on different rates, which vary based on a financial index.

Credit Ratings

In 2008, the insurers guaranteeing Jefferson County’s bonds lost their top credit ratings, after suffering subprime mortgage related losses. As a result, the yields on the bonds surged more than three-fold in one month to 10 percent.

The swaps compounded the increased borrowing costs because under the agreements the variable rates the banks paid the county declined.

Since then, Jefferson County’s annual sewer debt payment surged to $460 million, more than twice the $190 million it collects in revenue. The county couldn’t refinance the bonds without paying hundreds of millions of dollars in fees to get out of the swaps, and it didn’t have the money to do that.

JPMorgan is now in negotiations to prevent Jefferson County from filing the biggest municipal bankruptcy since Orange County, California defaulted in 1994.

Bank Losses

The Jefferson County transactions have also forced losses on the bank. Jefferson County owes JPMorgan more than $600 million for the swaps and the bank has so far not forced the county to pay.

The unregulated world of derivatives, which provided Wall Street banks with enormous fees, was ripe for corruption, said Taylor, the MSRB’s former executive director.

“Until you get strong ethical rules put in place nationwide, you’re asking for problems,” he said.

A December federal indictment of former Jefferson County Commission President Larry Langford alleged that JPMorgan paid an Alabama banker and former chairman of Alabama’s Democratic Party to get involved in the sewer financing deals. JPMorgan gave William Blount, a long-time friend of Langford, almost $3 million to arrange the swaps associated with the county’s sewer refinancing, the indictment said.

Bear Stearns Cos. paid Blount $2.4 million while Goldman Sachs Group Inc. paid him $300,000 after Langford told JPMorgan to include the firm as a condition of a $1.1 billion swap agreement in 2003, the indictment said. The banks weren’t charged.

Rolex, Jewelry

Blount helped Langford get a $50,000 loan and paid for jewelry, a Rolex watch and expensive clothing from Ermenegildo Zegna SpA and Salvatore Ferragamo SpA, the indictment said.

Langford, Blount and Blount’s associate Albert LaPierre, who was allegedly paid $219,500 by Blount for his help, have all pleaded not guilty. In response to a parallel civil complaint filed by the SEC, the men have argued that the agency doesn’t have jurisdiction over swaps.

Given the scope of the case so far, it’s not surprising that the SEC would consider charges against JPMorgan, said Jim White, a former financial adviser to Jefferson County. The county hired White after it had agreed to do the swap deals.

“If you know all that, and you’ve read the indictment, then you wouldn’t be surprised,” White said yesterday.

The Justice Department investigation of JPMorgan is looking at transactions across the country.

Collusion Allegation

In Pennsylvania, two school districts sued JPMorgan last year, alleging the bank colluded with a financial adviser to reap excessive, undisclosed fees on derivative deals. The lawsuits were dismissed by a federal judge, who said the transactions weren’t covered by securities laws.

The Erie City School District sued JPMorgan and a Pennsylvania financial adviser in federal court alleging they colluded to reap more than $1 million in excessive fees on a derivative deal.

Erie’s school board, which said it had “rudimentary, laymen’s understanding of the derivatives market,” met in September 2003 with JPMorgan banker David DiCarlo. DiCarlo told the board that the district could make $750,000 by selling a swaption, or an option on an interest-rate swap, according to an audiotape of a board meeting.

DiCarlo told the board he didn’t know how much JPMorgan would make on the deal. Pottstown, Pennsylvania-based Investment Management Advisory Group, which had been recommended to advise the district by DiCarlo, told board members that the district was getting a fair price for the contract, the tape shows.

The district ended up paying JPMorgan $1 million in fees for the $750,000 it had received upfront, according to data compiled by Bloomberg.

To contact the reporter on this story: William Selway in San Francisco at wselway@bloomberg.net. Martin Z. Braun in New York at mbraun6@bloomberg.net."

Companies rushed to issue nearly $10 billion of bonds eligible for the Federal Reserve’s Term Asset-Backed Securities Loan Facility, or TALF

TO BE NOTED:

TALF-Backed Bond Offerings Take Off

A government program designed to help unfreeze the credit markets may have been slow to get out of the gate since its March launch, but it seemed to be picking up speed Monday, The Wall Street Journal reported. Companies rushed to issue nearly $10 billion of bonds eligible for the Federal Reserve’s Term Asset-Backed Securities Loan Facility, or TALF, The Journal said.

Included in that was a $5 billion TALF-eligible bond offering put together by JPMorgan Chase on behalf of a small group of investors, the newspaper said. Banks sold $8.2 billion of securities under the plan in March and $2.57 billion in April, the newspaper noted.

Go to Article from The Wall Street Journal »"

JPMorgan held “sham negotiations” about a potential merger and made public some confidential data

TO BE NOTED: From Bloomberg:

"WaMu Asks Judge for Probe of JPMorgan Merger Conduct (Update1)

Share | Email | Print | A A A

By Vivek Shankar

May 1 (Bloomberg) -- Washington Mutual Inc., the bankrupt former parent of the biggest U.S. bank to fail, asked a Delaware judge for an investigation of JPMorgan Chase & Co. related to its conduct in acquiring the failed bank.

The motion expands on a Texas case in which stakeholders in Washington Mutual seek billions of dollars from New York-based JPMorgan, alleging misconduct leading up to the $1.9 billion acquisition of Washington Mutual’s thrift unit.

Washington Mutual, based in Seattle, alleged JPMorgan held “sham negotiations” about a potential merger and made public some confidential data that drove down the value of its thrift unit. Joseph Evangelisti, a spokesman for JPMorgan, declined to comment on Washington Mutual’s investigation request filed today in U.S. Bankruptcy Court in Wilmington, Delaware.

Regulators seized Washington Mutual’s banking units and sold them to JPMorgan on Sept. 25. Washington Mutual filed for bankruptcy the next day.

The case is In re. Washington Mutual Inc., 08-12229, U.S. Bankruptcy Court, District of Delaware (Wilmington).

To contact the reporter on this story: Vivek Shankar in San Francisco at vshankar3@bloomberg.net"

$3 billion loss on the books from its deal to rescue investment bank Bear Stearns

TO BE NOTED: From Reuters:

"Fed data shows big losses on Bear Stearns deal

Thu Apr 23, 2009 5:59pm EDT

By Ros Krasny

CHICAGO (Reuters) - The U.S. Federal Reserve lifted the lid on its efforts to shore up the financial system on Thursday, and in the process, showed a $3 billion loss on the books from its deal to rescue investment bank Bear Stearns.

The Fed provided more details of the huge increase in its balance sheet that occurred over the final months of 2008, rounding out data already issued on a weekly basis. Bank officials also said more disclosure could be on the way.

Combined assets in the Fed system hit $2.25 trillion as of December 31, 2008, up a sharp $1.33 trillion from a year ago.

The U.S. central bank has enacted an alphabet soup of new programs to support the credit markets.

Thursday's statements specifically provided a window into the Fed's Commercial Paper Funding Facility, created in October 2008 to provide liquidity to the CP market, and the three "Maiden Lane" limited-liability companies created by the New York Fed as part of broad-ranging rescue efforts.

Much interest was on the original Maiden Lane LLC, which was formed in mid-March 2008 as part of the orchestrated takeover of the failing investment bank Bear Stearns by JPMorgan Chase.

Some $1.7 billion in gains logged by the CPFF were swamped by the $3.1-billion unrealized loss in Maiden Lane, which included $54 million in "professional fees."

Maiden Lane was created to hold an asset portfolio that JPMorgan found too toxic to assume in whole, and analysts said Thursday's report bore out that assessment.

Fed figures showed that some 40 percent of the assets in Maiden Lane were Level 3, or basically illiquid, at year-end. That included $5.5 billion in commercial mortgage loans and $2.4 billion in swap contracts.

All other assets in the fund were dubbed Level 2, with valuations based on prices for similar instruments in active markets.

"Maiden Lane is just a collection of crummy assets so there was always a potential for a loss," said William Fleckenstein, president of Fleckenstein Capital in Seattle.

Maiden Lane II, a holding company whose assets are dominated by subprime mortgages, logged a $302 million loss. Maiden Lane III managed $45 million in net income on its portfolio of asset-based collateralized debt obligations.

Both are holding companies created when insurance giant American International Group (AIG.N: Quote, Profile, Research, Stock Buzz) was taken over by the U.S. government in September 2008.

Fed officials said various aspects of the bailout effort also combined to reduce payments made to the Treasury in 2008 to $31.7 billion from $34.6 billion, a decline of 8 percent.

Still, the Fed's holdings of commercial and residential loans were said to be in relatively good shape, with the majority regarded as performing.

Over time that could create substantial upside, the officials said, as real estate markets recover.

Fed officials said they were mulling ways to increase disclosure of the type of information contained in Thursday's reports, including potential quarterly releases."