The economic damage wrought by a handful of financial firms has left the American public clamoring for a pound of flesh. This week, New York Attorney General Eric Schneiderman tried to satisfy that desire. He chose a curious first scalp.

Schneiderman, who is co-chairman of a state-federal mortgage-fraud task force created by President Barack Obama, hit JPMorgan Chase & Co. with a lawsuit alleging the kind of deceptive behavior all too common in the run-up to the financial crisis: creating and marketing defective mortgage-backed securities that blew up on investors. The conduct, however, took place not at JPMorgan but at Bear Stearns, the investment bank JPMorgan bought in a government-arranged sale as the financial crisis was unfolding.

Holding JPMorgan responsible for Bear’s sins might be a no-brainer had this been a normal market transaction. But the circumstances surrounding the acquisition were anything but routine. Over a panic-stricken weekend in March 2008, the U.S. pushed JPMorgan to buy Bear. Worried about the effects of a bankruptcy on the broader financial system, the government sweetened the deal by agreeing to purchase $30 billion of Bear’s risky mortgage assets.

Discounted Price

True, JPMorgan bought Bear for a song, paying $10 a share, or $1.5 billion for a company with more than $11 billion in common equity. That steeply discounted price reflected the risk JPMorgan was assuming. Unlike a typical acquisition, which involves due diligence and book-scrubbing, the deal closed in a matter of days.

JPMorgan initially set aside $6 billion for legal costs and losses associated with Bear’s assets but, as JPMorgan Chief Executive Officer Jamie Dimon explained in the company’s 2008 annual report, it quickly emptied that reserve. (Dimon also predicted the Bear acquisition would ultimately add $1 billion annually to JPMorgan’s earnings).

Schneiderman coordinated his lawsuit with the Justice Department, the Securities and Exchange Commission and the Federal Housing Finance Agency, putting the federal government in the awkward position of punishing JPMorgan for behavior it had, in fact, encouraged.

Worse, the move runs the risk of sending a troubling message to markets, which might not be as willing to step in during times of crisis. The Dodd-Frank financial law established a government process for rescuing failing firms like Bear and Lehman Brothers Holdings Inc. to avoid the need for a taxpayer bailout, a process that requires private market participation.

Under so-called resolution authority, the Federal Deposit Insurance Corp. can take over a large, failing firm and eventually transfer ownership to private hands. Depending on the agreement’s terms, legal liability would either transfer to the buyer or remain with the FDIC. The Schneiderman lawsuit all but guarantees that companies in the future will refuse to acquire troubled bank assets unless they are legally immunized, slowing down workouts and forcing the FDIC to deal with claims.

That isn’t to say Bear’s conduct, as alleged by Schneiderman, should go unquestioned. The lawsuit alleges Bear’s mortgage unit packaged $212 billion in mortgage bonds from 2003 through 2006 and underwrote “an astounding number of securitizations that have gone sour.” Some choice e-mails from Bear traders suggest they knew exactly what they were peddling. Losses so far total $22.5 billion and are expected to grow -- money Schneiderman is seeking to recoup from JPMorgan on behalf of investors.

Curious Target

Let it be noted that Bear was not alone in this behavior. Let it also be noted that JPMorgan was not the most egregious of the bunch, making it a curious first target for a task force charged with investigating the mortgage mischief that characterized the last decade.

Perhaps one reason Schneiderman chose to go after JPMorgan is that private lawsuits already outlined much of the poor underwriting by Bear. Many allegations in the complaint are strikingly similar to lawsuits filed by private insurers, such as Ambac Financial Group Inc. The Schneiderman lawsuit even repeats an error contained in Ambac’s suit, which wrongly names PricewaterhouseCoopers LLP as Bear’s external auditor. (Deloitte & Touche LLP was Bear’s external auditor; it paid $19.9 million to settle claims by Bear investors.)

Surely there are other banks -- and executives -- more deserving of scrutiny for their work in the realm of mortgage-backed securities. In announcing the lawsuit, Schneiderman suggested additional legal action will follow. Good. This is a worthwhile endeavor. But for a true reckoning, we have to hope he picks his targets more wisely.

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