The Fannie and Freddie Fiasco

Richard Epstein*

Richard Epstein

Richard Epstein

On April 15, the United States Circuit Court of Appeals for the District of Columbia will hear a high stakes appeal from the hedge funds Perry Capital and Fairholme Capital related to the bailout of Fannie Mae and Freddie Mac. At issue in the case is the legality of an amendment made by the government in August 2012 to the original 2008 bailout. That Third Amendment, as it’s called, has caused a major violation of shareholder rights. (Full disclosure: I have worked as an advisor for a number institutional investors involved in this case and have also written a comprehensive account of all aspects of this complex litigation.)

To recap the history, both Fannie and Freddie—which are government sponsored entities, or GSEs—were under extreme stress in the fall of 2008, and in order to shore up their finances, they entered into a Senior Preferred Stock Purchase Agreement (SPSPA) with the United States Treasury. Under the SPSPA, Treasury agreed to contribute up to a combined $200 billion in cash to both companies in exchange for a senior-preferred stock that carried a 10 percent dividend. Eventually, Treasury lent about $188 billion per year, which carried a hefty $18.8 billion annual dividend payout. Under the SPSPA, both Fannie and Freddie were given the unlimited option to defer payment of the interest, which was then added to principal as an “in-kind” obligation, at a 12 percent interest rate. Unlike many private corporate bailout plans, this deferment did not call for any loss of control by Fannie and Freddie. Treasury thus held a new senior-preferred stock. The old private-preferred shareholders now held junior-preferred stock.

The negotiation over SPSPA took place in a tense financial environment. In the summer of 2008, with crisis in the air, Congress passed the Housing and Economic Recovery Act (HERA), which implemented two new statutory programs.

First, it authorized Treasury on a temporary basis through the end of 2009 to extend temporary assistance the GSEs to help them through this rough financial patch. HERA implicitly assumed that Treasury would be dealing at arm’s length with the directors of a private corporation, which explains why it had a statutory obligation “to protect the taxpayer” as it sought to stabilize financial markets and “to prevent disruptions to the availability of mortgage finance.”

Second, HERA authorized the newly minted Federal Housing Finance Agency (FHFA) to place any impaired corporation into a conservatorship under its control “to preserve and conserve the assets” of the corporation in conservatorship, and to manage its operations until it returned to health, at which point the conservatorship would end, and the business would return to private ownership. The existing shareholders, not the Treasury, are the only persons to whom that duty is owed.

Unfortunately, the drafters of HERA did not anticipate the potent interaction between these two provisions for the GSEs. Bothactions took place together, so that one federal agency ended up negotiating with a second. At this point, without the institutional shield that a private board of directors would have supplied to its preferred and common shareholders, the federal government was on both sides of the SPSPA. To make matters worse, the then head of FHFA was Edward Demarco who had previously served as a high-ranking Treasury official. In ordinary corporate settings, having friendly parties on the opposite sides of a deal looks like a slam-dunk breach of the fiduciary duty of undivided loyalty that FHFA owed to the then-existing preferred and common shareholders of the GSE. Indeed, under HERA, the directors of any covered corporation had the right to refuse any deal that Treasury offered to them. With an independent board, Treasury should protect taxpayer interests. Indeed, if both sides do their job, the bailout should be a win/win transaction.

The conflict of interest took a more ominous turn with the adoption of the Third Amendment between FHFA and Treasury nearly four years later. At that time, the market had quieted down, and the GSEs were making timely dividend payments on Treasury’s preferred stock. Nonetheless, FHFA and Treasury ripped up the old agreement, and substituted in its place a new deal that created a “net worth sweep” whereby all of the funds received by the GSEs were paid over to Treasury as a dividend, even in amounts far in excess of the original 10 percent dividend. The consequences have been huge. Without the Third Amendment, virtually all the senior-preferred stock would have been redeemed. With the Third Amendment, about $128 billion that could have been used to redeem the preferred shares has been reclassified as a dividend payment, rather than a return of capital.

FHFA has argued that this one-sided renegotiation really worked for the benefit of the GSEs junior-preferred and common shareholders because it stopped a destructive cycle in which the GSEs would continually have to borrow more money from Treasury in order to make its dividend payments. Not so. That argument rests on an odd factual predicate, given that the GSEs had always made timely dividend payments. It also rests on an equally odd legal premise that ignores the 12 percent in kind option to defer immediate cash dividend payments. The gist of the government’s argument therefore is this: by relieving the GSEs of the obligation to pay dividends when they are broke, Treasury gets all the cash when the companies are solvent.

The bottom line is that the government wins on the upside and loses nothing on the downside. The transaction here is, for all intents and purposes, indistinguishable from a decision by FHFA to transfer title of the junior-preferred and the common to Treasury without consideration. How else can one describe FHFA’s simple declaration, as conservator, that all value associated with the junior-preferred and common shareholders ends up in Treasury’s hands with nothing whatsoever in return. To be sure, this deal is artfully structured so that the junior-preferred and common shareholders retain their legal title to the shares. But that title is stripped of all of its economic significance.

Normally, ownership of shares carries with it voting rights. But once FHFA took over, the shareholders were stripped of their right to remove hostile directors. Normally shares carry with them both dividend and liquidation rights. But here the dividends were paid to the senior-preferred shareholders (i.e. Treasury) to whom FHFA owed no fiduciary duty, and they so rigged the transaction that junior-preferred and common shareholders would get nothing if the government ever decided to liquidate their interest. In effect the transaction leaves the GSEs' ordinary shareholders in limbo. It is just as the lawyers for Perry Capital and Fairholme Capital describe it: a de facto nationalization of private wealth in blatant breach of FHFA’s fiduciary duty, as aided and abetted by Treasury. To make matters worse, this entire transaction took place after 2010, when Treasury’s temporary bailout authority ran out. Redoing this deal from top-to-bottom in a one-sided way is not a simple modification of the original SPSPA that benefits both parties. It is a new deal entered into by the government and for the government.

It was therefore utterly astounding that Judge Royce Lamberth in the District Court granted the government’s motion for summary judgment on September 30, 2014, without allowing any discovery about the underlying facts. The only way in which that outcome was possible was to interpose a variety of dubious procedural defenses that let him duck the obvious conclusion that no fiduciary should ever be able to wipe out the interests of its beneficiaries.

The key to understanding how this took place is to note that litigating against the federal government is always an uphill battle in federal court. Even the most rock-solid case that GSE shareholders bring against the government has at best a 50 percent chance of winning, so heavy is the government’s thumb of the scales of justice. To see why, just ask the question of what would happen if the deal between FHFA and Treasury had been put together by two private parties, one a trustee and another a preferred stock investor, whose conduct was subject to regulation under either the federal securities acts or state corporate law. There is no doubt that this artful transaction would have subjected both parties to serious civil and criminal sanctions because of the deviation from accepted norms of corporate transactions.

But once two branches of the federal government are involved, all sorts of procedural obstacles intercede. Thus in Perry Capital, the FHFA brief first argues that the private shareholders of the GSE do not have standing to bring this case because Section 4617(f) of HERA provides that “no court may take any action to restrain or affect the exercise of powers or functions of the Agency as conservator.” That provision makes perfectly good sense in the common situation where FHFA is entering into deals with third parties over the management and disposition of the assets, given that pesky lawsuits could make it difficult for FHFA to discharge its duties as conservator.

But this provision, as Michael Krimminger of Investors Unite noted in his brief, is lifted verbatim from the Federal Deposit Insurance Act, where it was never construed to block a suit that the beneficiaries under the conservatorship could bring against the conservator. In situations such as this, where FHFA has no intention to protect the private GSE shareholders, then no matter how broad its powers, it necessarily steps outside its role of conservator and should be subject to suit for its alleged derelictions. To let the statute insulate a conservator from suit undermines its specific statutory obligations. By overlooking the grossest breach of duty, FHFA’s reading necessarily deprives these shareholders of the minimum due process protections for their property. It also takes private assets and converts them to government use. Both of these are per se constitutional violations of the Due Process and Takings Clauses. No statute should receive so grotesque an interpretation as the government puts on this one.

FHFA then backs up its initial claim for total judicial immunity by pointing to Section 4617(b)(2)(A)(i) of HERA, which provides that FHFA shall “as conservator or receiver, and by operation of law, immediately succeed to—(i) all rights, title, powers and privileges of the regulated entity, and of any stockholder, officer, or director of such regulated entity”—the entities here being the GSEs. The government reads the 2012 decision in Kellmer v. Raines as containing this simple injunction: “Read the statute; read the statute; (3) read the statute.” But literalism over the word “all” is no substitute for a more systematic statutory analysis, which asks whether this reading guts the fiduciary duties imposed in the same statute.

Kellmer involved a suit brought against Franklin Raines, the former head of Fannie Mae, for his breach of fiduciary duties to the corporation. At this point there is no conflict of interest between the shareholders and FHFA, so that the case only stands for the proposition that FHFA gets to control these suits. But it is a leap to read this statute to insulate FHFA from all charges of breach of fiduciary duty, brought by individual shareholders on behalf of the corporation. As with the previous section, this grotesque outcome converts FHFA from a conservator to an outright owner and is utterly inconsistent with the purpose of the statute. Context matters. Sound statutory interpretation always requires the implication of principled exceptions to bring the operation of the statute in line with its stated objectives.

The D.C. Circuit will soon have the opportunity to redress the grievous errors made by Judge Lamberth and to decide that government conservators, like private conservators, cannot loot the corporations whose shareholders they are sworn to protect.

*Considered one of the most influential thinkers in legal academia, Richard Epstein is known for his research and writings on a broad range of constitutional, economic, historical, and philosophical subjects.

An Unconstitutional Bonanza

Richard Epstein

In a previous column, Grand Theft Treasury, I highlighted the recent lawsuits (now numbering seventeen) brought against the United States in connection with its controversial conservatorship of two government-sponsored enterprises, The Federal National Mortgage Association (Fannie Mae) and The Federal Home Loan Mortgage Corporation (Freddie Mac).

The occasion for that story was the then-recent public announcement that about $59 billion had been paid to the United States Treasury as a “dividend” on the $188 billion in purchase money payments that Treasury had advanced to Fannie and Freddie pursuant to agreements that it had entered into with its conservator, the Federal Housing Finance Agency (FHFA). The two key agreements were the initial “Senior Preferred Stock Purchase Agreement” of September 26, 2008, and the Third Amendment to that agreement of August 17, 2012. (All the relevant documents can be found here).

This past week two events of note took place. First, the United States filed its much anticipated brief in Washington Federal v. United States, defending itself against charges that it had seized the wealth of the private shareholders of Fannie and Freddie. The second is that FHFA, on behalf of Fannie and Freddie, paid the Treasury another $39 billion in dividends on the original advances of about $188 billion. Combined with the earlier payments, the Treasury has now virtually recouped its huge original advance. The prospect of further and equally lucrative paydays promises to turn Treasury’s erstwhile “rescue operation” into an unparalleled bonanza for the government. The deal looks almost too good to be true. Indeed, a close examination of the government’s responsive brief reveals that it is.

The Original Deal

At root, the legal challenges to the government’s action rest on the one-sided terms of the original stock purchase agreement and especially the controversial Third Amendment. In September 2008, FHFA wrested control away from the Boards of Directors of Fannie and Freddie by installing itself as the conservator of both corporations, charged with managing all of their affairs. Armed with these extensive powers, FHFA promptly entered into a sweetheart deal with Treasury whereby Treasury purchased a new issue of senior preferred stock from Fannie and Freddie for about $188 billion, which carried with it a 10 percent dividend, and an option that allowed Treasury to acquire some 79.9 percent of the common stock for the nominal price of $0.00001 per share. That transaction drove down the prices of the common and (now junior) preferred. The 2012 Third Amendment replaced the previous 10 percent dividend with a “sweep” to Treasury of all the net profits of Fannie and Freddie, as of January 1, 2013.

The deal was made just as both companies were returning to profitability. As commonly expected, the revised agreement has proved wholly one-sided. Treasury has reaped over one hundred billion dollars and, through the profit sweep, has assured that Fannie and Freddie will never amass a single dime to enable the repurchase of the senior preferred stock. A conservatorship requires the conservator to act in the best interest of its beneficiaries—here the shareholders of Fannie and Freddie at the time the conservatorship was imposed. The original stock purchase agreement, and most emphatically the Third Amendment, which benefited only FHFA and Treasury, were signed in blatant violation of that basic duty. FHFA’s responsibility to the shareholders demands, at the very least, was that the Third Amendment be unraveled, and not exalted.

The Government’s Response

In speaking and writing about this issue (which I have done as a paid consultant for several hedge funds), I have often been asked how the government could defend itself in these dubious transactions that would be regarded as both intolerable and illegal if done by private parties. The government brief does not provide an acceptable answer to that question on either procedural or substantive grounds.

The Procedural Move.The government’s initial move is to refer to a key provision of the conservatorship law that it reads as making it impossible for the shareholders to have their day in court. Thus under 12 U.S.C. § 4617(b)(2)(A), FHFA shall “as conservator or receiver, and by operation of law, immediately succeed to—(i) all rights, titles, powers, and privileges of the regulated entity, and of any stockholder, officer, or director of such regulated entity with respect to the regulated entity and the assets of the regulated entity.” According to the government, this provision silences the shareholders because all their rights and powers have been transferred to FHFA.

That extravagant claim makes sense only so long as the interests of FHFA are aligned with those of its shareholders. The obvious distress of many financial institutions means that something has gone amiss. It is therefore a legitimate legislative judgment to grant the new government officials the power to pursue all claims that the corporations and their shareholders could bring against outsiders.

In support of its position, the government cites a 2012 Circuit Court decision, Kellmer v. Raines, which held that only FHFA was in a position to sue the former officers and directors of Fannie and Freddie for the breach of their duties to the corporation. That court insisted that, as a general proposition, its sole job was to “read the statute,” from which it concluded that “all rights, titles powers, and privileges” meant just that.

Therefore, on the basis of Washington Mutual, the government now insists that individual shareholders cannot sue FHFA and Treasury either as owners of shares or “derivatively” (that is, not in their own right but on behalf of the corporation). Thus the government concludes that persons who claim that billions of their dollars have made it into the treasury lack “standing” to challenge the FHFA and Treasury in court on, it appears, any and all legal grounds.

Two responses are appropriate. First, it is an absurd literalism to read the statute as though it contains no implied and necessary exception for those cases in which shareholders claim that FHFA has acted in violation of the duty of loyalty to them. The general legal maxim is that no person shall be a judge in his own cause, which is just what the government does with its wooden reading of the statute. The judicial injunction to read the statute means to read itas a whole, so as to make sense of all its moving parts, not just some.

Second, read as the government would have it, the statute is flatly unconstitutional because it denies individuals and their property the protections afforded against the government by the Fifth Amendment to the Constitution, which says “No person shall . . . be deprived of life, liberty, or property, without due process of law.” This, at a minimum, gives them the right to a hearing before a neutral and impartial judge in cases that involve major disputes over the nature and validity of substantial property claims.

The canon of constitutional avoidance holds that all statutes should be construed to avoid any serious clash with the Constitution “unless such construction is plainly contrary to the intent of Congress.” The government’s interpretation of the statute flouts that rule; if adopted, it should lead to the statute’s invalidation to the extent that it bars shareholders from the courtroom door.

The Substantive Move. The government’s second response is that even if they are allowed into Court, the shareholders of Fannie and Freddie really have nothing to complain about because their property has not been taken. At one point, the government makes the weird claim that this action should be barred because the plaintiffs do not allege that the Government has the citizen’s money in its pocket.” The technical reason for that claim is that Washington Mutual did not allege that the government had taken the money, but only that it had suffered a reduction in its shares’ value as a result of the government’s action.

Yet that perceived defect in pleading is easily remedied. The explicit purchase agreement took stock from the corporations in exchange for the infusion of cash. The taking comes from the fact that the value given to Fannie and Freddie was less than the value taken from the corporations. Phrased in this way, there are 100 billion reasons why money that belonged to the two corporations ended up in the pockets of the United States after the last two major sweeps.

The argument that these transactions count as takings is no more complex than the simple claim that the government forcibly takes the house of A, worth $100,000, for a mere $25,000. The forced purchase on unequal terms is a taking of $75,000, which should be enjoined unless the government ponies up the remaining $75,000. The situation does not change if the government plunks down that $25,000 in cash in exchange for a mortgage upon the property for $75,000, which it then empowers itself to collect by renting out the premises, keeping all the rents net of expenses for itself.

The Third Amendment to the Stock Purchase Agreement represents just this kind of one-sided transaction. Yet the government seeks to avoid this obvious implication by three specious arguments. First, it claims that there really was a mutually beneficial bargain here. After all, the Third Amendment was needed “because of a concern that the Enterprises, although solvent with Treasury’s assistance, would fail to generate enough revenue to fund the 10 percent dividend obligation.” Fat chance. Indeed, the one way to magnify the miniscule risk of default is to strip Fannie and Freddie of liquidity by the unilateral “dividend” payment made to the government. As a conservator, FHFA is supposed to defend shareholders, not fork over their money to Treasury.  

Next, the government offers two more threadbare arguments for its position. The first is that the time is not “ripe” for a complete accounting because the books have not closed on the transaction. But the goal in this case is to stop the bloodletting before the patient is dead, not to let the government go on with its rigged scheme until that future day when it will solemnly pronounce that it is just too late to unravel this complex transaction.

Finally, the government claims that the shareholders of Fannie and Freddie have assumed the risk that they will be looted. After all, an extensive body of law, much of which comes out of the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA), takes the highly contentious line that all banks know that they cannot challenge government regulations because they have willingly entered into a highly regulated area. Consequently, they do not have the requisite “investment-backed expectations” that they will be free of government regulation.

But this lawsuit is not a case where the government has acted pursuant to its general powers to regulate thrift institutions. Those cases are worlds apart from the present for two reasons. First, the source of the shareholders’ disaffection here is the purchase agreement of the senior preferred stock, and not any form of general government regulation of banks that have otherwise failed. Second, those cases do not contain the obvious element of self-dealing which pervades the Third Amendment.

Notwithstanding the government’s efforts to sugarcoat the obvious, this deal remains one of the most lopsided and unfair transactions in the annals of United States history—which says a lot about the sad state of public law and finance today.

In Defense of JP Morgan

  Richard Epstein

JP Morgan Chase (JPM) just had a bad week dueling with the federal government. First, it got slapped with a $5.1 billion settlement with the Federal Housing Finance Agency (FHFA) for its mortgage dealings with Fannie Mae and Freddie Mac; then, it got wrapped into a criminal investigation involving Bernie Madoff’s Ponzi scheme, which the government now insists that JPM should have detected in its role as Madoff’s banker before the scandal broke.

The financial toll of the various government initiatives against the bank is likely to top $25 billion, a sum that places a substantial dent even in the bank’s hefty capital structure. The reputational and business losses could amount to far more. The adverse consequences could wreak havoc on thousands of employees, customers, and shareholders. In both civil and criminal proceedings, the Department of Justice is bringing to heel a bank that came into two major mistakes. First, the bank did business with the federal government. Second, it was regulated by it.

The FHFA Settlement

Last week, JPM entered into a $5.1 billion settlement with FHFA, which took over the operation of both Fannie and Freddie when the two companies were forced into an unwanted conservatorship by FHFA and the Treasury at the height of the financial crisis. I have commented critically in an earlier column, Grand Theft Treasury, on the high-handed and indefensible nature of this transaction, which was crammed down the throats of Fannie and Freddie’s preferred and common shareholders on terms all too favorable to the federal government.

On this matter, I have acted as a consultant to several hedge funds not involved in the current litigation. The gist of my criticism of the government position is that Edward DeMarco, then the acting head of FHFA, engineered a deal with Timothy Geithner, then Secretary of Treasury, which consciously enriched the Treasury by the onerous terms of the initial conservatorship. To be sure, the 2008 transfer is subject to rival interpretations. But the same cannot be said of the notorious Third Amendment to that 2008 agreement, in which DeMarco and Geithner by fiat simply announced that all dividends of Fannie and Freddie, which had returned to profitability, would from then on generate “a full income sweep . . . to benefit taxpayers for their investment.”

The size of that sweep amounted to about $59 billion. In his comments on the recent settlement, DeMarco continued the farce, reiterating his job was “preserving and collecting Fannie Mae’s and Freddie Mac’s assets on behalf of taxpayers,” without bothering to mention that his fiduciary duties as conservator ran to the shareholders of Fannie and Freddie whose pockets he helped to pick.

Unfortunately, JPM does not get the kind of preferential treatment that the DOJ gives to other government agencies. Indeed, the terms of the FHFA/JPM settlement agreement are warped themselves, given that $4 billion of the basic liabilities were for actions undertaken by Bear Stearns and Washington Mutual before they were taken over by JPM in March and September of 2008 respectively—when no one else was willing to buy them and the government in fact encouraged JPM to save them.

At this point, another dispute has arisen about whether the FDIC may have to repay JP Morgan for some of those losses. The normal rule is to hold the successor corporation responsible for the wrongs of the predecessor (unless such liabilities have been clearly assumed, which doesn’t seem to be the case). But in the circumstances here, the FDIC bears that loss for getting JPM to make the acquisitions necessary for preserving the health of the U.S. economy.

The situation is worse still because it was well known that, starting with the Housing and Community Development Act of 1992, the United States imposed on Fannie and Freddie “an affirmative obligation to facilitate the financing of affordable housing for low- and moderate-income families in a manner consistent with their overall public purposes,” while at the same time “maintaining a strong financial condition and a reasonable economic return . . . .”

The two goals are deeply incompatible. The initial target was for low- and moderate-income housing to constitute 30% of the total market, a figure that actually amounted to 55% in 2007, just before the housing market collapsed. It was no great mystery that those aggressive programs had to result in a deterioration of loan quality. What does remain unexplained is how DeMarco can claim that Fannie and Freddie were innocent victims of a scandal that federal legislation helped create.

The entire episode is an embarassment. Fannie and Freddie should not get this money; and, if they get it, they should not turn it over to the taxpayer, which is just what will happen. The entire system is flawed from top to bottom.

The Ponzi Scheme Investigation

The only ray of light resulting from the FHFA’s litigation was that the settlement agreement did not constitute “an admission by any of the JPMorgan Defendants of any liability or wrongdoing whatsoever . . . .” That critical point helps insulate JPM from criminal charges here.

The specter of criminal charges against the bank remains live, however, thanks to an overzealous United States Attorney for the Southern District of New York, Preet Bharara.  Bharara is now thinking of bringing criminal charges against JPM for its alleged involvement in the massive fraud that Madoff committed against his multiple investors.

Bharara’s basic theory is that JPM (and its predecessor Chemical Bank) was Madoff’s banker during this period and thus should have known that he could have been involved in a Ponzi scheme. Therefore, JPM should have referred the entire matter over to government officials for further investigation. Bharara does not appear to deny the categorical statement of JPM’s General Counsel Stephen Cutler that JPM “did not know about or in any way participate in the fraud.”

If that statement remains uncontested, criminal charges against JPM should be off the table. But Bharara seems to think that a criminal case could be brought because key JPM employees had suspicions about Madoff’s possible misconduct, which they should have reported to government officials sooner than they did. That is thin gruel for a criminal case, given that JPM had no private information about Madoff’s illegal schemes. It is worth noting that in the exhaustive SEC study on its own woeful performance, the Office of Inspector General cleared all SEC employees of “any financial or other inappropriate connection with Bernard Madoff or the Madoff family that influenced the conduct of their examination or investigatory work.”

Thereafter the OIG found that the SEC had ample information in the form of “detailed and substantive complaints” from 1992 to 2008, all of which raised “significant red flags” about Madoff’s operations that the SEC then overlooked in “three examinations and two investigations” that turned up nothing. JPM is not mentioned once in that 457-page study. Why then does Bharara single the bank out for potential criminal investigation over four years later? Of course JPM knew that Madoff’s auditor, Friehling & Horowitz, was a penny-ante firm not equal to the task. But so too did the SEC and everyone else. Perhaps JPM knew that Madoff reported returns that were “too good to be true.” But again, so too did the SEC and everyone else.

Nonetheless, Bharara stokes this possible criminal investigation to leverage a favorable deferred prosecution agreement (DPA) with JPM. Under these agreements the government agrees to delay a deadly prosecution, but only if the target corporation plays ball. The basic set up runs as follows. Bharara, as prosecutor, has complete discretion on whether to press criminal charges. Those charges, without more, can easily trigger the suspension of JPM’s charter by the Office of the Controller of the Currency (OCC), which is running a parallel civil investigation of JPM. The OCC has met with Bharara, but “didn’t try to dissuade” him from considering a criminal investigation of JPM. The two parties thus seem to be working the same angle.

This cooperation between the OCC and Bharara is wholly intolerable. Any criminal conviction requires proof beyond a reasonable doubt, and normally carries with it a modest fine. Given the known collateral consequences, Bharara can impose heavy sanctions on JPM without proving anything in court. For the threat of prosecution to be credible, moreover, it has to be exercised at least once.

Just that happened when Arthur Andersen closed its doors in August 2002 after it was criminally indicted for its lax oversight of Enron, which went into bankruptcy in 2001. Nearly four years later the Supreme Court in 2005 unanimously tossed out that ill-conceived indictment for not alleging “the consciousness of wrongdoing” needed to support a conviction. Andersen’s ultimate vindication was of scarce comfort to the 85,000 employees who lost their jobs in the meantime.

Don’t expect, however, that this precedent will slow down Bharara and the OCC. For comfort, they need only to look at the sordid 2006 DPA agreement that then-New Jersey District Attorney Chris Christie extracted from Bristol-Myers Squibb in a securities case, which I denounced at the time as “The Deferred Prosecution Racket.” Christie used his leverage to gain a seat in the BMS Board Room and reserved the right to haul BMS on the carpet for an informal mini-trial in his office to decide whether the company had violated the terms of its DPA. To top it all off, he also required BMS to make a special gift (a practice since banned) to his alma mater, Seton Hall Law School, to support its ethics program.

Alas, the OCC and Bharara are following the same script to exert control over JPM that they could never get under ordinary government oversight. Such use of the DPA is often defended as the best means to restore public confidence in corporations that would fold if subjected to criminal prosecution. Not here. It is hard to see how dragging JPM through the mud is anything more than a crude attempt to force CEO Jamie Dimon to resign.

To be sure, it remains an open question whether the DPA is ever an appropriate government tool, or whether the entire notion of corporate criminality should be scrapped in favor of a policy that restricts criminal liability to corporate officers and directors who consciously orchestrated company misdeeds.

These fine points of corporate criminal responsibility are a side-show in Bharara’s threadbare investigation. A decade ago, then-Deputy Attorney General Larry Thompson wrote a notorious 2003 memorandum that listed nine squishy factors to guide prosecutors on corporate criminal indictments. But his memo never did explain how he planned to guard against the inversion that arises when the simple indictment is more deadly than an ultimate conviction. So it turns out there is indeed much to investigate after the early stages of this case against JPM.

Bharara should turn his not inconsiderable prosecutorial skills to ask whether he and the OCC should be subject to criminal or civil sanctions for their evident abuse of their extensive prosecutorial powers. While he is at it, he might prod his boss Attorney General Holder to probe Edward DeMarco for his blatant abuse as conservator in the ongoing Fannie and Freddie saga. The Obamacare rollout is not the only mess on the government’s plate.