J.P. Morgan Takes a Beating on Friday....does the math support it?

The blogging community and the press have been having a field day since hearing that J.P. Morgan has been named in a lawsuit filed by Irving Piccard, the Madoff Trustee.  J.P. Morgan has been accused of being "thoroughly complicit" in the Madoff fraud and therefore took a hit in the market. I'm not going to get into the specifics or legality of this (I invite our partner Oscar, if he feels the need), but I did feel the need to address how the market reacted and what they are pricing in, at least initially, into the merit or potential payout from the lawsuit.

JPM closed Thursday at $45.46/share, or a market cap of $177,762.3 billion. Twenty four hours later it was at $44.59 (a loss of 1.91%) and closed at a market cap of $174,360.3 billion (-$3.4 billion decline). Just a little background, the S&P 500 Banking Index or the BIX was flat to up (+0.22%) on the day. Irving Piccard's lawsuit is asking for $6.4 billion from JPM. Based on initial reaction from the market, they have priced in that JPM will more than likely have to pay. The market believes that JPM either has a 53% probability of paying ($3.4 billion decline in mkt cap / $6.4 lawsuit = 53%) the full amount or that JPM could end up settling for almost half of the $6.4 billion.

Since the Madoff name is like the ebola virus in the financial industry, I feel that JPM will vigorously contend this suit. Settling would be an implicit admission of guilt. In addition, since they were just the banker of Madoff's security company I don't believe the courts would contend that they were "complicit in the fraud"and therefore have responsibility in such a scheme. IF there is a settlement I believe it would be way below either the market or Piccard is hoping to get.
Disclosure: Long JPM

Courtesy of Floyd Norris from the NY Times:

http://norris.blogs.nytimes.com/2011/02/03/what-did-chase-know-and-when-did-it-know-it/?nl=business&emc=dlbka10