Penalties for sub-prime, Euribor, Libor ... $125bn?
While decisive action by US authorities primarily ensured the sub-prime crisis damage was largely contained, the banking industry is now faced with the challenge of dealing with the aftermath. According to a Reuters calculation, once the JP Morgan proposed $13 billion settlement with the US Justice Department on mis-selling sub-prime mortgages is concluded, the costs could soar to around $125 billion for the banking industry as a whole. Apart from the investigation into mis-selling of sub-prime mortgages—JP Morgan has already signed a $5.1billion settlement on this with the Federal Housing Finance Agency—the other big ones relating to rigging of the Libor as well as the Euribor, both benchmarks used for setting trillions of dollars of complex derivatives each year. While the Libor rigging is being investigated since early 2005, the Euribor investigation began two years ago when the European Commission raided a number of banks suspected to be involved in the rigging—the Euribor penalties, it is estimated, can be anywhere between 1% and 10% of the annual revenues of the banks involved.
While the penalties will be levied when they will, banks are already providing for them—in the case of Deutsche Bank, 1.2 billion euros were spent in legal costs in Q32013 and provisions of 4.1 billion euros have wiped out profits according to Reuters. In the case of JP Morgan which has set aside $23 billion to pay for legal issues, there are also the costs involving the London Whale’s trades, charges related to gaming electricity markets in California, even allegations of bribery by hiring the children of powerful Chinese families to help win business deals there. What is alarming, in the case of JP Morgan for instance, is that despite all the penalties, the board has continued to back Jamie Dimon. Indeed, the bank’s stock has continued to soar, a reflection of the view that as long as the bank is run profitably and the charges are not criminal, the bank is better served with Dimon at its helm—the Fed’s policy of keeping money very cheap, ironically, helps keep banks profitable. This is the first quarter that JP Morgan has declared a loss with Dimon at the helm. While getting banks to pay up the huge penalties is a victory for US officials in particular, at some point the Justice Department and other authorities need to start worrying about whether their actions are forcing banks to fix their very flawed risk and compliance controls. Though JP Morgan, for instance, is reportedly planning to assign 5,000 employees to help fix this according to one news report, for now there isn’t much to suggest the fines are having the impact they are supposed to—it is only when the next crisis occurs, to use Warren Buffet’s colourful phrase, that we will know how many people were swimming without any underwear.