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March 24th, 2014

The Federalist Paper: Swindler’s List

The Federalist Paper: Swindler’s List normally evokes thoughts of infamous names such as Bernie Madoff, Alan Stanford or Charles Ponzi. Seldom does the List receive the Federal government as a nomination. Yet, the recent $1.7 Billion fine and deferred prosecution agreement the U.S. Attorney levied on JPMorgan would shock Casablanca’s Captain Renault for its hubris. It is akin to citizens of Lexington and Concord, MA in 1780, penalizing a certain silversmith for not mentioning loudly enough the British were coming five years earlier. The government received multiple warnings and documentation of Madoff’s fraud beginning in 1992, yet JPM is brought to the dock for not mentioning this concern in October 2008, six weeks before Madoff collapsed. Equally fascinating is the whole of proceeds do not go to Madoff victims, but a large portion will be retained by the government. JPM has become the financial equivalent of those who failed to aid Kitty Genovese, but JPM was only aware of Madoff’s symptoms over a decade after they began. The Federal government’s inability to recognize its own failure in this situation while instead pretending to triumph over JPMorgan, which had to capitulate or be put out of business, is not a sign of quality government.

In normal commerce, in even the largest enterprise, one can find a responsible person who can referee multiple disputes between one customer and multiple departments of the large enterprise for the sake of cost efficiency and for the sake of common sense. Unfortunately, this same concept does not exist in the Federal government. Despite the billions of dollars JPMorgan has remitted to the government for recent fines for the mortgage issues and for the Madoff situation, it is still enmeshed in a huge legal claim against the FDIC to receive nearly $2.0 Billion for WAMU mortgage collateral. Why wasn’t a settlement and netting of this claim included by the U.S. Attorney in last Fall’s mortgage settlement to save an expensive rehashing in court?

We have entered an era where JPMorgan has become the ATM for the Federal authorities. There is no prospect for JPM offering resistance as regulators have the unfettered ability to pull the plug on JPM with no consequences to regulators for overreaching or for inflicting systemic damage. The events of 2008 were dire and led to wide financial pain, but the convenience of perpetually labeling JPM and other banks as Pandora’s Box (while at the same time ignoring the role of Federal policy, borrowers irresponsibility and natural economic cycles) constitutes shallow thinking and is likely to lead to systemic problems during the next financial downturn. This circumstance will lead the banks to resist the opportunity to accept Federal encouragement to buy the next Merrill Lynch, Bear Stearns, and Washington Mutual forcing the government into the banking business.

Two other recent developments have resurrected the wisdom of other recent legislative and executive acts: 1) The GM ignition problems and associated deaths and 2) The inclusion of private equity in Dodd-Frank due to its purported systemic risk. Several deaths and multiple injuries tracing back over a decade occurred due to a faulty ignition system. The defect is now getting a great deal of attention as victims’ families are pressing for compensation. During the faux bankruptcy of GM in 2009 when bankruptcy law was cherry-picked such that equally ranked creditors received unequal recoveries; two notable results occurred: known legal claims prior to the bankruptcy were terminated, which is normal in bankruptcy, and a nearly $20 Billion tax loss carried forward was permitted to be retained by new GM. That retention is not permitted by bankruptcy law. We now have the intriguing position where GM, earning billions per year tax free is legally permitted to dodge ignition victim claims by raising the defense of bankruptcy law, the same law which would have never permitted their tax free status or the selective protection of pension obligations. Victims’ counsel and the National Transportation Safety Board have indicated they are examining the notion GM committed fraud during the bankruptcy with respect to not fully revealing the ignition issue. If the NTSB sues GM over this, including suing the controlling party at the time of bankruptcy, the U.S. government, we will witness the Federal government suing the Federal government. Extending the logic of the Sun Capital case last August, a victory by the NTSB will mean the Federal government, which is not collecting taxes from GM, will be on the hook for GM’s liability.

The Treasury Department has recently published a report suggesting large asset managers are “systemically important” and should therefore be regulated by the Federal Reserve not the SEC. As is predictable in turf wars, the SEC would not like to see its brief reduced. Consequently, the SEC has supported the industry’s position that asset managers, no matter how large, do not pose any risk to the system as any losses they incur are borne by their investors. Simultaneously, we now have the SEC arguing by inference that PE is not systemically important, while the Congress and the administration insist PE remain regulated by the SEC due to its systemic risk. The Federal government, via Dodd-Frank, grabbed the high hanging fruit by regulating PE.

I’m Rob Morris and I approved this blog.

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