Who has two index fingers and is suing the FDIC? Photographer: Pete Marovich/Bloomberg

JPMorgan Chase is suing the Federal Deposit Insurance Corporation for more than a billion dollars, which is so mind-manglingly tone-deaf that it requires some explanation beyond "they think they have a case." One possibility is that so many government agencies have sued JPMorgan for so many billions of dollars that it figured no one would notice one little billion-dollar lawsuit running the other way. Another is that so many government agencies are suing JPMorgan for so many billions of dollars for so much badness that the concept of "tone-deaf" no longer exists at JPMorgan.1

The third and most tempting explanation is, "this is so dumb that they must be right." I would like nothing more than to tell you that the FDIC cruelly abused JPMorgan and that, as embarrassing as this lawsuit is, fair is fair and JPMorgan is only -- soberly, reluctantly -- standing up for what is right.

I don't particularly think that? JPMorgan has been hinting at this lawsuit for a while,2 and during that hinting I very temperately said that their theory was "nuts." Here is JPMorgan's complaint and ... I don't know, I guess I am slightly more persuaded, maybe "nuts" was a bit hasty. But still I am not especially convinced.

The dispute goes like this. JPMorgan bought Washington Mutual's assets from the FDIC in September 2008. JPMorgan agreed to assume and "to pay, perform, and discharge, all of the liabilities of the Failed Bank which are reflected on the Books and Records of the Failed Bank," and the FDIC's receivership agreed to indemnify JPMorgan for any lawsuits and liabilities that it did not assume. WaMu, like a lot of banks, sold a lot of mortgages with a lot of fraudulent reps and warranties, and the people who bought those mortgages want someone to sue; either JPMorgan or the FDIC's WaMu husk will do. Lots of them have sued JPMorgan, or the husk, or both.

So the question is mostly, were these future lawsuits -- some demanding that WaMu repurchase those mortgages, others for securities fraud -- liabilities "reflected on the Books and Records" of WaMu? The contract is sort of terrible -- there is no defined term for "Books and Records," or for "Books," though there is one for "Records"3 -- and JPMorgan interprets the phrase narrowly, to mean basically only liabilities that are on WaMu's balance sheet. On that theory, lawsuits that hadn't been filed yet in September 2008 would not be JPMorgan's problem.

The FDIC interprets it broadly, to include obligations under contracts -- like the mortgage sale documents4 -- that were reflected in WaMu's records and public disclosure. So the FDIC finds it important that a March 2008 WaMu 10-K mentioned the possibility of "having to repurchase securitized loans if it were found to have violated representations and warranties contained in the securitization agreements," and that WaMu actually reserved -- on its balance sheet -- against those risks. In the FDIC's view the "books and records" thing is intended to exclude secret liabilities run up by corrupt bankers, not contingent liabilities under fully disclosed contracts.

So who is right? Meh. One lesson here is, "don't write terrible contracts." Obviously, if you are negotiating a distressed bank's takeover in some haste, it is tempting to fall back on old template contracts without reading the boilerplate, but what you get is dozens of pages full of "notwithstanding anything else in this agreement," and who knows what it all means. If you'd asked both sides to list 10 things that JPMorgan was assuming, and 10 things that it wasn't, someone probably would have written down "all this mortgage fraud" in one column or the other. Do that, negotiate it, and then write the agreed list on a napkin or whatever, and you'll get a better contract than this.

With the contract providing no enlightenment you've got to fall back on outside stuff, and here I am pretty persuaded by the FDIC's arguments. Like the fact that JPMorgan has said publicly in its risk factors that it would be on the hook for repurchase and indemnity obligations for WaMu mortgages.5 Or like the fact that JPMorgan "acquired from FDIC Receiver assets with a net fair value of nearly $12 billion," but only paid $1.9 billion for them.6 If JPMorgan wasn't taking on $10 billion of contingent risk, what was it doing?7

So I still don't love JPMorgan's odds here. But that doesn't answer the question, what is going on here? Here I think is the money quote from JPMorgan's complaint:

Following resolution of JPMC's indemnification claims, any amounts remaining in the WMB receivership would be paid out to WMB creditors, primarily to holders of WMB senior debt, a group currently constituted mainly of hedge funds and similar entities that have bought up WMB senior debt for pennies on the dollar. FDIC-Corporate acts as a guarantor of the FDIC-Receiver's indemnification obligations to JPMC under the P&A Agreement; however, JPMC believes that the FDIC-Receiver has sufficient assets to meet the existing indemnification obligations that are the subject of this action and that, if the FDIC-Receiver does so, it will not be required to call upon FDIC-Corporate's guarantee.

The receivership seems to contain about $2.7 billion, of which about $1.9 billion is money that JPMorgan paid the FDIC for WaMu. All they're doing is asking for some of their money back. And if they don't get it back, it will go to the WaMu senior debtholders, who in JPMorgan's vision are a bunch of freeloading vulture hedge funds, not to the government. JPMorgan is not betting that it's more sympathetic than the government. It's betting that it's more sympathetic than hedge funds seeking to profit from WaMu's failure. Which ... seems like a bad bet?

1 This is how I understand Hank Greenberg's lawsuits over AIG. He is old and his AIG stock is worthless, what does he have to lose?

2 Incidentally! The hinting came in the run-up to JPMorgan's $13 billion settlement with the government. That settlement prohibits JPMorgan from coming after the FDIC receivership for the $4 billion payment to the FHFA in respect of Fannie and Freddie included in that settlement (see paragraph 13). But JPMorgan's current complaint includes some Fannie and Freddie repurchase claims that JPMorgan settled but that weren't included in that $4 billion.

3 They are "any document, microfiche, microfilm and computer records (including but not limited to magnetic tape, disc storage, card forms and printed copy) of the Failed Bank generated or maintained by the Failed Bank that is owned by or in the possession of the Receiver at Bank Closing."

4 The FDIC's theory is actually more convoluted than this and involves repurchase rights under contracts related to mortgage servicing rights that JPMorgan expressly assumed.

5 "Accordingly, such repurchase and/or indemnity obligations arising in connection with the sale and securitization of loans (whether with or without recourse) by us and certain of our subsidiaries, as well as entities acquired by us as part of the Bear Stearns, Washington Mutual and other transactions, could materially increase our costs and lower our profitability, and could materially and adversely impact our results of operations and financial condition."

6 In more detail:

In exchange for WaMu’s ongoing banking operations – i.e., for "purchas[ing] substantially all the assets and assum[ing] all deposit and substantially all other liabilities of WaMu" – JPMC paid $1.9 billion in cash. P&A Agreement, Art. VII; see Am. Compl. ¶ 86. According to JPMC, however, the fair value of the net assets it acquired from FDIC Receiver in the WaMu transaction (i.e., WaMu’s assets net of its liabilities) was $11.99 billion at the time of sale. See Ex. 9, JPMC 2009 Form 10-K (2/24/10) at 144. Thus, by JPMC’s own reckoning, the total fair value of the assets and liabilities it assumed under the P&A Agreement, even after “[a]djustments to reflect liabilities assumed at fair value,” was more than six times greater than JPMC’s $1.9 billion purchase price.

7 Another outside indicator you could look at is: Are WaMu's victims suing the FDIC husk, or JPMorgan? This is a mixed bag; a lot of suits that JPMorgan wants to be indemnified for are against JPMorgan, but when I quote the FDIC's arguments its from a case where Deutsche Bank, as trustee for a lot of mortgage trusts, sued the FDIC receivership and only added JPMorgan later after the FDIC disclaimed responsibility.