What's Behind the FDIC, JPM Dispute Over Wamu

WASHINGTON — JPMorgan Chase's attempt to get the Federal Deposit Insurance Corp. to pay part of its pending $13 billion settlement with the Justice Department is just the latest chapter in a long-running dispute over the nation's largest bank failure.

The FDIC's 2008 sale of the $307 billion-asset Washington Mutual Bank's operations to JPMorgan was at the time almost anticlimactic, projected to cost the Deposit Insurance Fund nothing and granting Wamu customers an easy transition to a new bank.

But observers say Wamu's size, toxic portfolio and the fact that it was one of the crisis' early collapses contributed to years of subsequent battles over which party – the FDIC or JPMorgan Chase – is responsible for legal claims against the failed institution.

The battle has the potential now to disrupt JPMorgan's settlement with the government over an array of mortgage complaints, including those inherited from Wamu.

"This dispute has its origins in the purchase and assumption agreement between JPM Chase and the FDIC [that was] signed in 2008, where the FDIC takes the position that JPM assumed all liabilities of WaMu, and JPM asserts it has no liability for the pre-failure errors of WaMu related to these mortgage loans," said John Douglas, counsel at the law firm of Davis Polk & Wardwell and a former FDIC general counsel.

The status of ongoing talks between JPMorgan Chase and federal authorities to reach an agreement was still unclear Wednesday, but the news – reported by the Wall Street Journal and other outlets – that the bank wants the FDIC to pay part of its price tag added a significant obstacle.

The Federal Housing Finance Agency's $5.1 billion settlement with the bank over mortgages securities bought by Fannie Mae and Freddie Mac, announced Friday, appeared to protect the FDIC in its "corporate capacity" from future JPMorgan indemnification claims, but that could still leave unresolved future claims on the Wamu receivership managed by the FDIC.

Five years ago, the cleanup of the largest American thrift was a model of government-industry cooperation. JPMorgan Chase's successful bid to the FDIC to assume all of Wamu's deposits and the thrift's assets, while paying $1.9 billion to the agency, was in contrast to prior resolutions that had appeared more problematic. Just the previous summer, as failures started mounting, the agency seized the $32 billion-asset IndyMac Bank without having found a buyer, leaving the DIF with billions in projected losses and some depositors losing funds.

"Washington Mutual was, like IndyMac, a liquidity failure as opposed to a capital failure, and JPMorgan Chase seemed to solve a potentially pretty big problem for the FDIC," said Sanford "Sandy" Brown, a partner at Bracewell & Giuliani.

JPMorgan Chase chief executive Jamie Dimon hailed the Wamu acquisition at the time as making "excellent strategic sense" while then-FDIC Chairman Sheila Bair said Wamu's customers would see "a seamless transition." In her memoir on the crisis, Bair later recalled she was "particularly relieved that the Chase acquisition protected all of the uninsured depositors, given some of the heartbreaking instances of uninsured depositors at IndyMac."

But the deal was followed by a drawn-out bankruptcy for Wamu's holding company and billions of dollars of claims from the thrift's shareholders and bondholders, as well as holders of the failed bank's toxic mortgage-backed securities.

What emerged was a fundamental disagreement between the FDIC and JPMorgan over whether the 2008 Wamu deal left the acquirer liable for claims sought by MBS investors, or the FDIC receivership was responsible. Some outstanding claims in the receivership were covered under an amended 2012 settlement related to the holding company's bankruptcy, but others have not been settled.

Lawrence Kaplan, an attorney at Paul Hastings, said that in the fall of 2008 the FDIC and failed-bank acquirers, including JPMorgan Chase, were just in the initial phases of what would be the handover of more than 400 failed institutions.

"It was unfamiliar ground for both acquirers and the FDIC. You couple that with it being the largest failure ever, and there was a lot of uncertainty," he said. "The provisions on what liabilities were assumed became more sophisticated with subsequent iterations of the FDIC purchase agreement, which suggests that there was a need for additional clarity.... They've now used it more than 400 times. They've revised the agreement over and over again to address these ambiguities."

Since as early as 2009, JPMorgan has sent the FDIC at least 35 different letters arguing that the bank is not responsible to pay for claims related to Wamu's mortgage origination and servicing.

"There are enormous dollars at stake, and because the underlying [2008] document is not as concise and crisp as it perhaps could have been, this has become a big stumbling block," Douglas said.

Many of the MBS claims – generally related to alleged violations of representations and warranties in Wamu mortgages – were included in a 2009 lawsuit brought by Deutsche Bank National Trust Co. on behalf of securitization trusts seeking as much as $10 billion in damages. In various documents related to that proceeding, both the FDIC and JPMorgan argued the other was liable under the 2008 sale agreement.

"Under the unambiguous terms of the P&A Agreement... all risk of liability to DBNTC or the Trusts is borne by JPMC, not FDIC receiver," the agency said in a June 2010 court document.

But in a court filing the following November, JPMorgan argued the opposite, contending that "the court should enter partial summary judgment in JPMC's favor finding that the FDIC retained liability for Deutsche Bank's claims."

The Deutsche case, which is still ongoing, is separate from the government's more general settlement talks with JPMorgan. Following release of the FHFA settlement, the bank is said to be in talks with the Justice Department over a whole host of mortgage-related claims against the company, including securities JPMorgan packaged and complaints related to Wamu and Bear Stearns, which JPMorgan acquired as an open institution in the thick of the financial crisis.

Yet the outcome of the bank's settlement could have implications for other litigation, including the Deutsche case, where the question of whether the FDIC or JPMorgan Chase is liable is in dispute.

"If the FDIC makes a payment in one case, the plaintiffs in the other case would be able to argue, 'You already conceded the issue. Look how you handled it over there,'" Kaplan said. "The FDIC would have to go before the court and explain why the two circumstances are different."