The Financial Crisis’ Long Hangover

The sins of the past are weighing on Wall Street, hurting both bank profits and the public’s perception of financial firms. And new rules might not improve Americans’ opinions of Wall Street, as mortgages and bank credit get harder to obtain under stricter regulatory requirements.

The July earnings season revealed what kind of toll the mortgage crisis is still having on U.S. banks, as lawsuits, either resolved or pending, continue to shape voters’ views of the industry. At Bank of America Corp., litigation costs for the quarter ending June 30 climbed to $4 billion, compared with $471 million during the same three-month period in 2013, resulting in a 43 percent decline in profit. For JPMorgan Chase & Co., legal fees contributed to an 8 percent drop.

Those costs aren’t just weighing on banks’ bottom lines; their reputations are also being dragged down. Likely voters across all income brackets had the least amount of trust for Wall Street and investment banks, compared with community banks and the Federal Reserve, according to a Morning Consult poll published last month. Big banks and Wall Street were also the least trustworthy among Democrats, Republicans and independents.

Legal fees were a drag on second-quarter earnings for many U.S. banks, but many of those expenses stem from the mortgage crisis that began almost 10 years ago. And recent settlements are likely to weigh on profits in coming quarters.

For example, Citigroup Inc. this month agreed to pay $7 billion to settle government allegations that the bank sold problematic mortgage-backed securities in the years leading up to the housing crash, while Morgan Stanley agreed to pay $275 million for misleading investors when issuing residential mortgage-backed securities.

Both came in the same month as the four-year anniversary of the enactment of the Dodd-Frank law. That sequence of events has become an impediment to improving the banking industry’s reputation, according to a financials services lobbyist who spoke on background due to client concerns.

“Everybody sort of has a feeling that we passed a law and now they’re getting accused of committing crimes,” the lobbyist said, adding that the alleged crimes often occurred before Dodd-Frank. “That’s fueling a lot of the public perception that nothing has changed, when in fact a lot has changed.”

Industry proponents note that many of the lawsuits are tied to the practices of firms acquired by the banks years ago, from Bank of America’s purchase of Countrywide Financial Corp. in 2008 to JPMorgan’s acquisition of Washington Mutual the same year.

Last year, JPMorgan agreed to pay $13 billion to settle charges that it misled investors who purchased bundled mortgages from the bank. Bank of America has yet to reach a civil settlement with the Justice Department for similar allegations.

It also doesn’t help that mortgage rules created in the wake of Dodd-Frank, such as ability to repay (ATR) and qualified mortgages (QM), could make it harder for potential borrowers to obtain credit, particularly as banks keep an eye on potential litigation.

“Given the legal and reputational risks imposed by this regulation, banks are not likely to venture outside the bounds of the QM safe harbors,” Dale Wilson, president and chief executive officer of First State Bank in Texas, said last week in testimony before the House Financial Services Committee. He added that the rule “however well intentioned, will end up restricting mortgage credit making it more difficult for our nation’s community banks to serve a diverse and creditworthy population.”

In the meantime, a recent spate of fines and investigations involving European banks is also making it difficult for Wall Street to improve its public standing, since many of the firms have U.S. operations. French bank BNP Paribas SA this year said it would pay an $8.9 billion fine for violating U.S. sanctions. That came on the heels of Swiss bank Credit Suisse agreeing to pay $2.6 billion in penalties after pleading guilty to helping U.S. residents avoid taxes.

Pending cases against European banks include a claim by the New York attorney general’s office that U.K.-based Barclays Plc misled clients about activities in its so-called dark pool trading venue. Additionally, Deutsche Bank AG came under scrutiny from the Federal Reserve Bank of New York for financial reporting inaccuracies at the firm’s U.S. units, according to documents first published by the Wall Street Journal.

Some regulatory advocates reject the argument that the threat of legal action, or even costly settlements, will have the intended effect of preventing similar actions going forward, for foreign or domestic banks.

“The fines that have been levied have not been enough and have worked against deterrence and accountability,” said Amit Narang, a regulatory policy advocate at Public Citizen. “The best piece of evidence here is Jamie Dimon. He got a pretty good vote of confidence from the board after paying billions in legal settlements. If boards of directors are viewing these settlements as nothing more than the cost of doing business and an advantageous way of dealing with these investigations and rewarding CEOs then clearly the interest of deterring criminal activities is not being achieved.”