JPMorgan's Risky Bonds Plan Lost Billions, Insurers Claim

  • Insurers accuse bank of stuffing accounts with risky debt
  • Case shows how financial crisis still being fought in court

JPMorgan Chase & Co. stuffed two investment accounts with risky mortgage bonds almost a decade ago as the housing market started to crumble, lawyers for two insurance companies told a state judge, causing their clients to lose more than $1 billion.

"They saw steadily increasing risks and bad news and they did nothing in response," said Michael Allen, an attorney for Ambac Assurance UK Ltd. JPMorgan was reckless for assigning an inexperienced portfolio manager to the accounts who ignored investment guidelines and continued to buy subprime mortgages, despite numerous warning signs, attorneys for the insurers said Monday during their opening statements.

Tibor Nagy Jr., an attorney for JPMorgan, countered that the portfolio manager, Mark Stancher is highly respected by his colleagues and “absolutely qualified” to handle the accounts. Stancher had eight years of experience managing portfolios and was assigned because the “highly negotiated” agreements governing the accounts anticipated they would include those kinds of investments, Nagy said.

Two insurance companies sued the bank’s investment management unit in New York state court in 2008 and 2009, seeking damages linked to losses in the investment accounts. The cases are centered around home-loan pools that were a central part of the housing bubble that helped spark the worst recession since the 1930s, showing the fights over the origins of the financial crisis are still playing out.

Market Prices

Allen said declining asset-backed securities prices in March 2007 should have been a "wake-up call" to Stancher, who took the stand Monday following opening arguments.

"What he did was hit the snooze button, roll over and go to sleep," Allen said.

Nagy said that all of the securities in the accounts were investment grade or higher and that JPMorgan did an "extensive amount" of work monitoring their performance.

"These are not people who hit the snooze button," Nagy said. "These are people who were looking very carefully at these things at the time."

More Probes

Several banks are still being investigated by the Justice Department’s task force on residential mortgage-backed securities, and many are still facing suits seeking to force them to buy back bad loans, said Elliott Stein, an analyst for Bloomberg Intelligence.

"This case is a little different from most of the cases we’ve seen because it’s related to JPMorgan’s investment management practices, not its securitization practices," Stein said.

Assured Guaranty (UK) Ltd. and Ambac Assurance accused JPMorgan’s Investment Management of ignoring guidelines that required it to diversify the holdings in the accounts and instead filling them with subprime and Alt-A mortgage bonds even as the bank was shedding similar assets that it had originated.

Ambac in its complaint cited a Fortune magazine article from September 2008 that reported that JPMorgan Chief Executive Officer Jamie Dimon had concluded that subprime mortgages could "go up in smoke" and directed the head of securitized products to sell a lot of the bank’s positions.

Selected Assets

JPMorgan, the largest U.S. lender, argued all of the assets selected for the portfolios had investment grade rating, that the bank concluded they were safe investments after conducting "significant due diligence" and that it continued to monitor the securities after they were purchased.

The first suit was filed by Assured Guaranty in September 2008 on behalf of Orkney Re II Plc, an Ireland-based entity. The second was filed by Ambac in May 2009 on behalf of Ballantyne Re Plc, also Ireland-based.

Assured’s suit was dismissed in January 2010 before an appeals court revived it in November of that year, saying that the claims weren’t superseded by state securities laws.

New York State Supreme Court Justice Saliann Scarpulla is hearing the case without a jury and the trial is expected to last about four weeks. Scarpulla last month found that JPMorgan violated the investment-management agreement with Orkney, but denied the insurer’s bid for a pre-trial ruling finding the bank was grossly negligent.

The cases are Assured Guaranty Ltd. v J.P. Morgan Investment Management Inc., 603755/2008, and Ambac Assurance UK Ltd. v JPMorgan Investment Management Inc., both in New York State Supreme Court, New York County (Manhattan).

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