The sting in the tail of JPMorgan’s US$13bn deal

JPMorgan Chase chief Jamie Dimon has avoided a civil case over the bank’s dealings before the financial crisis, but criminal proceedings could still take place. Fortune Live Media/Flickr

Bankers don’t casually hand over US$13 billion to regulators without reason.

Needless to say eyebrows were raised on Wall Street following reports JPMorgan Chase has agreed to hand over a record “fine” to the Department of Justice.

While it is believed a deal has been done, no official statement has been made.

It’s likely JPMorgan chief Jamie Dimon and the company’s brains trust have decided this settlement is the best deal they can get, and much preferable to having the evidence presented in open court.

Instead, they will be able to sign off on an agreed statement of facts that the bank’s negotiators will undoubtedly make sure minimises damage to the bank’s reputation and its exposure to liabilities to the people and organisations harmed by its behaviour.

The case revolves around practices of packaging bad mortgages into securities.

In particular, it has been alleged that JPMorgan palmed off US$33 billion in toxic mortgage bonds to Fannie Mae and Freddie Mac from 7 September 2005 to September 2007.

The bank’s behaviour was even more galling as most of these transactions were completed before the crisis hit, and JPMorgan continued to record profits during 2008, when most of its competitors were tottering of the edge of insolvency.

JPMorgan may have dodged the bullet through some fleet footwork, but its role in creating the munitions that triggered the global financial crisis should not be forgotten. In 1997 it invented credit default swaps (CDS), which Warren Buffet warned represented “financial weapons of mass destruction,” and so they proved.

The settlement will come out of US$23 billion in “litigation reserves” that has been set aside, which suggests JPMorgan believes there is more pain to come.

Cases are pending over a US$6 billion loss caused by trading by the “London Whale” and an investigation into whether JPMorgan engaged in bribery by hiring of the children of Chinese officials.

Could this be the start of a more aggressive approach by the Department of Justice, and who might be next?

This development may assuage criticism of the government for going soft on bankers, but is it likely to stay the course? Lawrence McDonald, a former Lehman Brothers trading Vice President, suggests it will be difficult for the government to maintain its hard line because it will be dependent on the large banks should another crisis hit the world’s economy.

He recalled a deal done in 2008, when Hank Paulson, the then Secretary of the Treasury, pressured JPMorgan to purchase Bear Stearns and Washington Mutual, which were about to go under.

“In the next financial crisis, the JPMorgan of the future, the Jamie Dimon in 2020 or 2018, I think they say, ‘this is your problem – I’m not going to put my balance sheet at risk’.”

Such speculation underlies the fact that with the banking system in the hands of just a few, the government is dependent on their goodwill should another crisis occur.

The best way to judge the settlement is to consider not only whether it provides an adequate remedy for sins of the past, but whether it acts as a warning to others that future miscreants will be severely dealt with. The size of the fine certainly sends out a strong message.

The message has been heard by JP Morgan, which has put on an additional 3,000 compliance officers and pumped more than US$1 billion into technology-related compliance systems in 2013.

More significantly, the fact that the Department of Justice has signalled it will not provide indemnity against criminal action is likely to leave a lasting impression on Wall Street. The question now is, will US Attorney General Eric Holder have the courage to carry through with his threat, and will we see the sobering picture of bankers changing their Armani suits for orange jumpsuits any time soon?