Tuesday, November 19, 2013 - Too Good To Be True

Too Good To Be True

by Sinclair Noe

DOW – 8 = 15,967
SPX – 3 = 1787
NAS – 17 = 3931
10 YR YLD + .04 = 2.70%
OIL + .31 = 93.34
GOLD - .80 = 1276.20
SILV - .06 = 20.44

No record high today; not a surprise; it can't happen every day. So, we'll see if this is a pause or whether we have to wait six years till we have milk and cookies again. Likely the former, but you never know.

JPMorgan Chase and the Justice Department have reportedly finalized a $13 billion settlement and resolves an array of state and federal investigations into JPMorgan’s sale of troubled mortgage securities to pension funds and other investors from 2005 through 2008. The government accused the bank of not fully disclosing the risks of buying such securities which, as we know, failed.

JPMorgan had to acknowledge a statement of facts that outline the bank’s wrongdoing in the case. JPMorgan also backed down from demands that prosecutors drop a related criminal investigation into the bank and largely forfeited the right to try to later recoup some of the $13 billion from the Federal Deposit Insurance Corporation. The $13 billion deal also comes just days after the bank struck a separate $4.5 billion deal with a group of investors over the sale of toxic mortgage-backed securities.

The breakdown of the money includes a $2 billion fine to prosecutors in Sacramento and $4 billion in relief to struggling homeowners in hard hit areas like Detroit and certain neighborhoods in New York. Half of that relief will go to reducing the balance of mortgages in foreclosure-racked areas and offering a so-called forbearance plan to certain homeowners, briefly halting collection of their mortgage payments. For the remaining $2 billion in relief, JPMorgan must reduce interest rates on existing loans and offer new loans to low-income home buyers. The bank also will receive a credit for demolishing abandoned homes in an effort to reduce urban blight.

So, for about $6 billion of the deal, it appears JPMorgan is getting off quite easy; they were unlikely to see much or any of this, with or without a deal. Also, in the past, we've seen how loan mods have tended to favor the banks over the homeowners. And it'll be interesting to see what kind of terms they offer for low-income home buyers.

The government earmarked the other $7 billion as compensation for investors. The largest beneficiary is the Federal Housing Finance Agency. JPMorgan will pay the remaining compensation to a credit union association and state attorneys general in California and New York as well as the Justice Department’s own civil division.

The $13 billion settlement represents the largest amount that a single company has ever paid, even though they won't really “pay” the full amount, and it represents about a half year of profits for JPMorgan. While the deal put numerous civil cases to rest, it would not save JPMorgan from any criminal inquiries into its mortgage practices. Under the terms of the deal, the bank would also have to assist prosecutors with an investigation into former employees who helped create the mortgage investments. So, the biggest settlement ever, and it looks like JPMorgan will be able to hand pick a few lower level executives to throw under the bus for criminal charges.

How the hell is Jamie Dimon still in charge of this vast criminal enterprise? Well, for shareholders, it's just the cost of doing business.

MF Global, the collapsed brokerage firm that was run by former New Jersey Sen. Jon Corzine, must pay back $1.2 billion to ensure customers recover losses they sustained when it failed in 2011. The restitution is being levied following a complaint filed by the Commodity Futures Trading Commission earlier this year that alleges MF Global unlawfully used customer funds to meet the firm's needs in its final weeks; at least that's the quick explanation; more on that point in a moment.

MF Global Holdings, the New York-based parent company, imploded in October 2011 after making big bets on bonds issued by European countries that later fell in value. When it collapsed, more than $1 billion in customer money was reported to be missing. It was later determined the money was used to pay for the company's own operations. It was the eighth-largest corporate bankruptcy in US History. MF Global also faces a $100 million civil penalty due after it has fully paid customers and certain creditors.

MF Global admitted in the consent order that it is liable for some of the allegations pertaining to the acts and omissions of its employees as set forward by the CFTC. The commission is still involved with litigation against MF Global Holdings Ltd.

So, where did the money for restitution come from and where did the money go to when it just sort of vanished two years ago? When the music stopped on Halloween 2011, properly segregated customer funds were dispersed in the custody of a large number of financial institutions (such as JPMorgan), exchanges, clearinghouses, and other third parties in the form of investments and margin accounts and other perfectly permissible uses. Following the collapse, a trustee was appointed and one of the trustee's first tasks was to recover those moneys.

And according to the trustee, the banks were "quite cooperative" when it came to returning properly segregated customer accounts. JP Morgan, for instance, returned more than $1 billion in such funds within weeks of the trustee's appointment, as did BMO Harris Bank. Accordingly, such funds were never counted as composing any part of the $1.5 billion shortfall. The bank funds that took longer to retrieve, were different. These were the funds the banks received during, for the most part, that wild final week of October 2011, when money was being wired all over the place without much to discern what was being wired for what purpose. The origins of those transfers were hard to trace. Many of MF Global's banks handled its proprietary transactions as well as customer transactions, and without satisfying distinction.

So, in a way, the money wasn't exactly missing, it was just a matter of sorting out between assets on hand and outstanding claims against those funds. There were two categories of commodity customer at MF Global, each covered by slightly different CFTC rules. Those trading on domestic exchanges were protected by laws and regulations that very clearly required the broker to maintain segregated customer accounts and to perform certain daily calculations to ensure that sufficient moneys would always be available on hand to liquidate fully each account if needed.

When MF Global began to feel a liquidity crunch in the summer of 2011, its officials inquired into whether they could dip into the regulatory excess to find cash to prop up the proprietary end of their business. And technically speaking, they were allowed to dip into the “regulatory excess” in the foreign exchange accounts but only to the extent that there was an equal amount of “excess segregated funds” on hand for the domestic exchange accounts to make up for it.

On October 26, 2011 the technical line for segregated funds was crossed as MF Global officers dipped into regulatory excess funds, trying to right the ship before the end of the trading day, but that didn't quite work out and MF Global slipped into oblivion, and the funds slipped into oblivion; a shadowy ether not quite in segregated accounts, and somewhere between domestic and international, and nowhere to be found; or rather, the money was found, it just took about two years to find it.

And so the lesson here is that the money in that brokerage account is not quite as safe and secure as you might imagine.

The largest category of victims in the Bernie Madoff Ponzi Scheme will be first in line for compensation from a $2.35 billion fund collected by the Justice Department; this includes clients who lost cash through accounts with various middleman funds.

These so-called indirect investors represent about 70 percent of all the claims filed after Madoff’s arrest in December 2008, and about 85 percent of the claims for out-of-pocket cash losses. But because they were not formal customers of Mr. Madoff’s brokerage firm, they are not eligible to recover anything from the federal bankruptcy court, where the Madoff trustee has so far collected $9 billion to apply toward eligible claims. However, the indirect investors — at least 10,000 people and possibly many times that — are eligible for compensation from the federal Madoff Victim Fund.

Generally, anyone who withdrew less from their Madoff-related account than they paid in will be eligible to recover from the Madoff Victim Fund, even if they invested indirectly through the hundreds of “feeder funds,” investment groups and other pooled investment vehicles that poured cash into Madoff’s hands during his decades long fraud. Apparently, the use of feeder funds is a common tactic of Ponzi schemes, a way of building a network of fresh clients to be funneled into the scheme.

Unfortunately, there are some people who didn't live long enough to get their money back.

And the other connection here is the Madoff/JPMorgan link. JPMorgan was Madoff's banker and there is an ongoing criminal investigation that the bank turned a blind eye to Madoff's Ponzi scheme. The investigation centers on whether JPMorgan failed to alert federal authorities to Madoff’s conduct.

The trustee trying to recover funds for Madoff's victims says the bank generated handsome sums by allowing Madoff’s brokerage firm to “funnel billions of dollars” through its account with JPMorgan, “disregarding its own anti-money laundering duties.” The bank, starting around 2006, also pursued derivatives deals linked to Madoff’s so-called feeder-fund investors, the hedge funds that invested their clients’ money with him.

The case will most likely hinge on a series of e-mails that suggest JPMorgan continued to work with Madoff even as questions mounted about his operation. In one e-mail that surfaced in a separate lawsuit, a JPMorgan employee acknowledged that Madoff’s outsize returns seemed “a little too good to be true.”