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Don't Worry About How JPMorgan Maybe Helped Lehman Overlever Itself By Misusing Customer Money

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Is this JPMorgan Lehman thing a big deal? I mean the thing where JPMorgan used Lehman customer segregated securities as collateral for financing Lehman, allowing Lehman to overextend itself by a bit more than it otherwise would have, in pretty clear violation of the Commodities Exchange Act, although also maybe by accident? And where the CFTC fined them $20 million in a negotiated settlement today?

I don't know. On a monetary basis, no - the fine is pocket change to JPMorgan, though it's pretty big for the CFTC. And the misconduct also seems to be relative pocket change; in September 2008 the relevant mis-credited account was $330mm, vs. like $639bn of assets at Lehman, so 5bps of extra leverage, tiny yaaaay.*

On the other hand, though, there are some obvious things to get worked up about here, if that makes you happy. Here are three, in roughly ascending order:

(1) A huge interconnected financial institution collapsed under - let's hypothesize - the weight of its leverage, and JPMorgan was kind of standing there holding the bag and also levering the bag more than it was supposed to be levered. So you could be all, hey, how much did the one thing have to do with the other?

(2) I feel like there was something else where a futures commission merchant maybe misused customer funds recently? And JPMorgan was involved? Somehow? And it was kind of a big deal and lots of money is still missing and may never be recovered? Could we get more color on that? Maybe by looking at history? Perhaps?

(3) More fundamentally, remember how in 2008 there was a Financial Crisis™? Well, there was. And you could draw up a list of things that might have contributed to causing it, and you'd maybe put on that list, I dunno, just to pick a few possibles, (A) financial institutions that were over-levered and lost the confidence of their counterparties, bringing them down in a chain reaction, (B) a shadowy shadowy shadow-banking system based on triparty repo that exists outside of 75 years of banking regulation, and (C) securitization of crappy mortgages into crappy mortgage-backed securities that were sold to unsuspecting chumps. Also (D) tons of other, but let's focus on those three for a minute.

Let's start with (C). Remember how a while back:
- Citi sold some crap mortgages to some dopes, SO SUE THEM,
- the SEC did sue them, actually, and they reached a pre-negotiated settlement where Citi would pay $285mm and say it was neither sorry nor not sorry,
- US District Judge Jed Rakoff threw out that settlement because it didn't provide him enough information to know how much of a bad guy Citi was, and also:

in any case like this that touches on the transparency of financial markets whose gyrations have so depressed our economy and debilitated our lives, there is an overriding public interest in knowing the truth. In much of the world, propaganda reigns, and truth is confined to secretive, fearful whispers. Even in our nation, apologists for suppressing or obscuring the truth may always be found. But the S.E.C., of all agencies, has a duty, inherent in its statutory mission, to see that the truth emerges; and if fails to do so, this Court must not, in the name of deference or convenience, grant judicial enforcement to the agency's contrivances.**

- anyway that got overturned on appeal so whatever, go back to your contrivances, SEC.

Anyway, though, when Rakoff came out with that opinion I sort of scratched my head and wondered: why is the SEC bringing these cases to court? Like, if the SEC and Citi all agreed that (1) Citi wanted to pay $285mm to the SEC, (2) the SEC wanted to receive $285mm from Citi, (3) Citi would try not to do that specific bad thing any more, and (4) no one wanted to have to prove their case in a court, why not just agree to that, write a check, put out a press release, and never ask Jed Rakoff to approve it? I suppose there are some legalistic reasons but they seem sort of uncompelling to me.

And, it turns out, to the CFTC. The JPMorgan settlement requires no court approval. They're done. JPMorgan will be paying by wire transfer within ten business days; if for some reason they don't, the CFTC will suspend them from trading commodities and futures and stuff. Now obviously there's a different statutory scheme here but the parallels are instructive. Citi did some shenanigans that were arguably near to the heart of the Financial Crisis, the SEC agreed to a $285mm fine without too much public airing of grievances, and everyone got yelled at in court for not airing enough grievances. JPMorgan also did some shenanigans that were arguably near to the heart of the Financial Crisis, the CFTC agreed to a $20mm fine without too much public airing of grievances, the check will clear this week and it's already like the 14th story on the WSJ home page.

Which, fine - again, there's like a 90% chance this is all a pretty innocent error about an amount of money that, in the grand scheme of Lehman, was pretty small. It's just that, for all of Judge Rakoff's fuming about the lack of airing of facts in the Citi case - you kind of know those facts, right? Like, there's a dispute over how whether Citi's maybe not telling you that it was on the short side of its synthetic CDO was fraud, but there's not particularly a dispute over what it told you. I mean, there was a prospectus.

The thing about shadowy shadowy shadowbanking, though, is that it's shadowy. If you want the truth to emerge, the actions and possible malfeasance of Lehman's clearing bank in extending credit and rolling triparty repo in September 2008 seem like ... a nice place for the truth to emerge, no? A place where you might want to shine a little light? So I guess, if it wanted the opposite of that, it was smart of the CFTC to settle this one out of court?

In the Matter of J.P. Morgan Chase Bank, N.A. [CFTC]
Regulators Penalize JPMorgan Over Lehman Ties [DealBook]

* The CFTC is all "the [client] Account unlawfullly increased [net equity] based on Dealer Group 92, depending on the amount of credit utilized by [Lehman] at any particular point in time, by 5% or less and the Assets in Dealer Group 92 by less than 1%" - with "Dealer Group 92" being one of, presumably, at least 92 separate groups of Lehman accounts that were cleared by JPMorgan.

** I know! He really said that.


Appellate Court Willing to Entertain the Possibility that Citi Was Not Committing Fraud

I've had some fun these last few days proposing counterintuitive theories for why Citi might not suck as much as you probably think it does and it's nice to see others joining in the pastime, even if this sounds a little far-fetched: The district court’s logic appears to overlook the possibilities (i) that Citigroup might well not consent to settle on a basis that requires it to admit liability, (ii) that the S.E.C. might fail to win a judgment at trial, and (iii) that Citigroup perhaps did not mislead investors. That piece of rank conjecture is from the Second Circuit's opinion on an appeal* of Judge Rakoff's rejection of the settlement between the SEC and Citi over some mortgage-backed securities. Here's DealBook: