GUEST EDITORIAL

Bad example

10/25/2013

JPMorgan Chase, the nation’s largest bank, and the Justice Department tentatively have agreed to settle various lawsuits alleging misconduct in the bank’s marketing of faulty mortgage-backed securities before the financial crisis.

The $13 billion cost to JPMorgan is the largest such payment any financial institution has been forced to make; Justice is letting it be known that this case is a template for proceedings against other big Wall Street players. But does the reported settlement serve the ends of justice?

It does impose general accountability. Though hardly the worst offender in the mortgage-security business, JPMorgan certainly got rich packaging and selling low-quality home loans.

That game, in hindsight, contributed to the downfall of the U.S. financial system. The money the bank is coughing up now, under threat of civil and criminal liability, amounts to more than half of its profits last year.

The problem is that our legal system is supposed to hold people accountable for specific violations of specific rules. That’s not what happened to JPMorgan.

The government’s case rests not only on a sweeping assertion that the bank deliberately hoodwinked mortgage experts at Fannie Mae and Freddie Mac, but also on a novel interpretation of a previously obscure 1989 law that enabled the Justice Department to sue after the usual five-year statute of limitations had passed.

The law in question makes banks liable for fraud “affecting” a federally insured financial institution. But the government persuaded federal courts in New York that the “affected” institution could be the alleged offender bank itself.

Maybe the judges’ literal reading of the law is right. But we doubt either JPMorgan or anyone else realized it applied to them at the time of their alleged misconduct.

The $13 billion penalty is essentially a tax that will get passed along to JPMorgan’s shareholders and customers. Some $4 billion of it is earmarked for mortgage relief. Whether any of the potential recipients of this aid were harmed by JPMorgan is far from certain.

If the banks’ securities were fraudulent, the relevant victims would seem to be the pension funds and others who were duped into buying them. Yet they get only $3 billion from the deal. The set-aside for homeowners might hurt mortgage-bond investors if it results in a write-down of the underlying loans.

This is what happens when government comes under pressure to nail Wall Street hides to the wall. The populist narrative casts the crisis as a crime consciously perpetrated by greedy financiers on an unsuspecting public.

This version of events does not allow for the possibility that everyone, from Wall Street to Main Street to Washington, acted on widely held economic beliefs that turned out not to be true. The most important of these was that house prices would never come down and could therefore offset the risk of default on home mortgages.

The remedy for bubbles and panics, if any, lies in systemic reform — an objective that the case against JPMorgan and other big banks hardly advances at all.