A Cost-Benefit Analysis of Doing Bad Things

So I’ve been reading through bank financials, cuz they’re all reporting earnings next week and I don’t have a lot to do these days. I learned that, wow, bank earnings are heavily impacted by legal expenses. And by “legal expense” they mostly mean nondeductible penalties for doing illegal things.

All banks have established litigation reserves but most keep them secret
(except Credit Suisse, Deutsche, JP Morgan).

Publishing litigation reserves is a lot like saying, Yeah we know we did bad stuff and expect to pay this much in penalties, because we already performed the cost-benefit analysis before doing it.


Are you a bank considering willful violations of the law? Here are some recent settlements to provide basis for your own cost-benefit analysis.

Selling Misrepresented CDOs
Wachovia Bank sells $40M worth of worthless CDOs to LBBW Luuxemburg and an additional $5.5M to the Zuni Indian Tribe. Wachovia agrees to pay $11.2M to settle SEC charges after becoming part of Wells Fargo.
Net Profit: $34.3M

More CDO Securities Fraud
JP Morgan structures $1.1B worth of bad CDOs for $18.6M in fees, sells $150M of them to various investors. JP Morgan agrees to pay $153.6M to settle SEC charges.
Net Profit: $15M, although it also took an $880M loss on the CDOs it *couldn’t* unload, so maybe the Commission thought they had suffered enough?

Selling Subprime Loans
Morgan Stanley sells $2.5B worth of subprime loans. The loans result in $160M worth of investor losses. Morgan Stanley makes $1.1M in underwriting fees. Morgan Stanley agrees to pay $275M to settle charges.
Net Loss: $273.9M

A Shitty Synthetic CDO
John Paulson pays Goldman Sachs $15M to help him make a $1B bet on a synthetic CDO. Goldman Sachs gets two other banks, IKB and ABN Amro, to be the counterparty on that bet. IKB loses all its money and ABN Amro pays Goldman $841M to get out of the losing bet. Goldman Sachs agrees to pay $550M to settle SEC charges.
Net Profit: $306M, although Goldman had to turn most of that $841M over to John Paulson.

Unregistered Stock Exchange Selling Unregistered Securities
Ethan Burnside operates Bitcoin and Litecoin Stock Exchanges. Burnside receives 12081 litecoins and 2141 bitcoins in transaction fees, plus 11450 litecoins and 210 bitcoins in listing fees — a total of $515k according to October 2013 exchange rates. Burnside agrees to pay $68k to settle SEC charges.
Net Profit: $446,291

Never willfully violate the Securities Act without first performing a thorough cost-benefit analysis.

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