Tag Archives: JP Morgan

Revenge on the Street – J.P. Morgan Fined for Bernie Madoff’s Ponzi Scheme

J.P. Morgan can’t seem to catch a break lately as on December 12th (yes I know I’m late), the banking giant was charged $2 billion for ignoring red flags related to Bernie Madoff’s Ponzi scheme. To understand this story, we have to go back several years.

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This is Bernie Madoff, the villain behind the whole debacle. In 1960, Madoff founded Bernard L. Madoff Invesment Securities, a wealth management firm. Over the decades, he gained the reputation of being a spectacular money manager as he consistently generated highly successful returns for his investors. However, as the 2008 financial crisis loomed over the markets, it turned out that Madoff’s entire firm was a fraud, a fake, as fake as this Chinese rip off of Apple.

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You see, Madoff was running something called a Ponzi scheme. A Ponzi scheme occurs when a wealth manager gathers money from a group of investors and funnels it to other investors but says that they are the returns he earned from his investing strategies. In reality, there is no fancy trading strategy. Its all just one giant loop and it relies on a continous flow of funds. If investors stop giving or demand their money back, then the scheme falls apart. But with his wit and charm, Madoff kept this scheme afloat for decades. He built relationships with the most powerful and influential figures in the business world and convinced them to invest in his fund. Eventually he also attracted funds from less wealthy individuals and even various charity organizations.

Madoff’s investors were extremely pleased with Madoff’s consistent returns. Even during the periods when the market was on the decline, Madoff’s firm generated positive returns. However, this eventually drew the attention of other investing specialists on Wall Street. Madoff’s investing strategy revolved around buying large-cap firms such as Coke and AT&T and also purchasing options in those stocks as well. Ideally, this strategy should have limited the portfolio’s volatility. Nevertheless, his portfolio should still have been correlated with the market. However, Madoff even made positive returns in times when the market was falling. In the early 2000s, several other investors brought the issue up to the Securities and Exchange Comisssion, the regulatory body that governs the financial sector. However, their pleas were to no avail.

The house of cards collapsed in 2008. As the financial crisis caused the economy to plummet, a large group of investors wanted their money back. Due to the nature of the Ponzi scheme, Madoff did not have enough money on hand and was unable to repay his investors. Eventually, he confessed to his crimes and was brought into custody by the FBI and charged with 150 years in prison.

Jamie Dimon

Well what does this all have to do with J.P. Morgan then? Bernie Madoff operated his wealth management firm through J.P. Morgan. 4 years after Madoff’s imprisonment, J.P. Morgan agreed to settle for a fine of $2 billion following allegations by federal prosecutors that the the bank had ignored various red flags regarding Madoff’s operations. Madoff opreated out of J.P Morgan for roughly 15 years. I don’t know how deep bank’s usually track the activities of their clients but I just got my debit card cancelled for a possible suspicious activity when I hadn’t even used it in over 6 months. My guess is that in 15 years, a couple of hints may have dropped on a desk somewhere in the J.P. Morgan office. Of course, as I covered on this segment before, J.P. Morgan is looking to settle all its legal issues and be done with them once and for all. Thus, it is possible that they might have just accepted to settle case even though they could have pooled their resources to summon enough evidence to prove them innocent.

Its always nice to see crime pay. But its a tragedy that the crime wasn’t detected earlier. If you leave aside the millionaires and billionaires, a lot hardworking people and charities trusted their money in Madoff’s hands. Its heartbreaking to hear about their life’s savings vanish over night. If you’re interested, this 45 minute documentary regarding the scandal contains interviews with various people who had to come out of retirement and start working again at an old age because they lost their savings thanks to Madoff. Though certain regulations can be tedious and disruptive to business, I’m all in favor for regulations that makes it easier to catch any future similar cases that could hurt so many innocent people.

“In today’s regulatory environment, its virtually impossible to violate the rules”
-Bernie Madoff

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Revenge on the Street

Lately, I had been having writers block and had not been able to write a new article. But after a new interesting breaking story, a catchy title, and some inspirational electronic music, lets get rolling.

Speaking of rolling, heads are rolling on Wall Street these days; mainly, JP Morgan’s head. What is JP Morgan? Well its only the eight largest bank in the world and the largest bank in the United States based on assets. Originally, on August 13, it was announced that JP Morgan was being investigated  by the United States Department of Justice for its sale of mortgage backed securities in the period leading up to the 2008 financial crisis. The Department of Justice claimed that prior to the crisis, JP Morgan had misrepresented the quality of mortgages it was packaging into assets and selling to investors. More specifically, it is claimed that JP Morgan had misrepresented subprime and risky mortgages to investors as safe and sound assets. However, as we all painfully discovered in 2008, many mortgages across the United States were lent out to irresponsible and unworthy borrowers. When they defaulted on their mortgages, the mortgage backed securities collapsed and the price of houses plummeted. By the way, before we move on, if any of that jargon regarding the financial crisis was confusing to you, check out this EXCELLENT graphic explanation of the crisis.

After weeks of negotiations between JP Morgan CEO Jamie Dimon and Attorney General Eric Holder, Dimon finally settled to pay $13 billion of fines to the Department of Justice regarding the investigation. Even though many people assume that Dimon agreed to settle because he wanted to avoid future legal costs in the case of a potential civil suit, I like to believe that Eric Holder put on a Batman costume, and gave Dimon a beatdown in a poorly lit room. Rumor has it that Dimon was heard yelling the following words:

“If you’re a financial institution threatened with criminal prosecution, you have no ability to negotiate…you cannot win..you have a gun to your head”, said Warren Buffet, a couple a days ago. So maybe my theory on how the negotiation went down might not be so far-fetched.

So where will the $13 billion go? $9 billion of it will go to the government to help repay the taxpayers for the $188 billion bailout of Fannie Mae and Freddie Mac, two large semi-private mortgage issuers. They too had bought mortgage backed securities from banks like JP Morgan prior to 2008, and once homeowners defaulted on their mortgages, they too went under. The other $4 billion will go directly to help struggling homeowners pay their outstanding mortgages.

This will surely eat a large chunk out of JP Morgan’s profits for the next quarter. $13 billion is no small amount. According to a study by Bloomberg, JP Morgan’s $13 billion fine is bigger than Southwest Airlines’ market value, Google’s revenue for the third quarter, and JP Morgan’s Consumer Banking revenue for the third quarter.

size of fine

Is JP Morgan hurt? Definitely. Is JP Morgan done for? Definitely not. It still is and will remain to be, a very profitable bank. In 2012, JP Morgan recorded profits totaling to a whopping $32 billion. That’s profits, not revenue! It is true that compared to other recent legal fines that financial institutions have faced, this one is much larger.

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But as the Joker said in the Dark Knight: “Its not about the money. Its about sending a message.”

(Am I on fire with the Dark Knight references or what.)

What makes this case so significant is what it symbolizes, and that is the revenge of Main Street. By that, I mean that since the crash of 2008, not many banks or financial institutions had been prosecuted regarding the shady financial voodoo that went down prior to the economic collapse. Many people who had been severely effected by the crisis are still furious to this day that the banks are not being punished for their wrongdoings. And who can blame them? Because of the games played by bankers, lives across the globe were changed for the worse.

However, just like many things in life, there is no black and white. There are no perfect good guys or pure bad guys. Everything is somewhere in the middle. To understand what I mean, we have to turn around and look at the government. Firstly, it is crucial to note that the sales of mortgage backed securities at JP Morgan were occurring mainly in 2 subsidiaries, Washington Mutual, which was a bank that was known for issuing mortgages, and Bear Sterns, an investment bank. Prior to the financial crisis, these entities were independent companies. However, they both went bankrupt after the housing bubble collapsed. After their bankruptcy, the government persuaded JP Morgan to buy these institutions and save them from insolvency. So one could very easily make the argument that the US government is now trying to punish JP Morgan for owning the very entities that it made it purchase 5 years ago in order to save the United States from utter financial meltdown.

Secondly, why is it that the US government waited 5 years to prosecute JP Morgan? Why not act shortly after the crime was committed? The Department of Justice will claim that it takes a very long period of time to truly crack financial cases. Years of transactions must be analyzed, accounts dating back many years must be studied, and a definitive crime must be found. However, the more likely reason is that the government didn’t want to drive troubled banks off the cliff in 2008 by bringing down legal cases on them. Thus, they decided to look away from their wrongdoings for many years and only started to take them seriously once the economy picked up. Again, the government’s actions fall into a certain gray area. They ignored a crime for several years only to pick it up again. Doesn’t look like an example of pure good will does it?

Many parts of this settlement deal have not yet been finalized. We should receive more information regarding the deals in the following weeks. Until then, enjoy the song that Jamie Dimon has been listening to the most these past several weeks.

This country is a lot better off because Jamie Dimon has been running JP Morgan
-Warren Buffett