Wells Fargo and JPMorgan Chase, showing no ill effects from a foreclosure fraud settlement that was supposed to penalize them for fraudulent misconduct, both announced robust earnings gains today. Matt Stoller has a good look inside the numbers. But I was intrigued by the fact that both banks attributed stronger mortgage lending numbers for their earnings gains. Here’s JPM:

JPMorgan was helped by growth in many of its businesses, as consumers gradually began to spend more and businesses increased borrowing. Wholesale loans were up 23 percent over the same period a year ago, while credit card sales increased 12 percent and mortgage applications surged 33 percent. Deposits in branches increased 8 percent. At the same time, lower charge-offs helped results in the bank’s huge credit card business.

The increase in mortgage applications helped turn results around in the JPMorgan’s retail mortgage business, which reported a profit of $1.75 billion compared with a loss of $399 million a year ago.

And Wells Fargo, from this writeup by Brett Philbin:

Wells Fargo & Co.’s first-quarter profit rose 13% as the banking company was bolstered by a surge in mortgage banking and company executives expressed confidence the housing market is approaching a turning point [...]

The bank also experienced a big spike in mortgage applications, which rose 20% from the fourth quarter, as refinancings accounted for 76% of that total.

During a conference call with analysts, Wells Fargo Chairman and Chief Executive John Stumpf signaled the bank’s mortgage business continues to improve, noting that “when you have the dynamics of higher rental rates and lower home values at attractive financing rates, there’s a point in time where the market is going to clear.”

So what’s this about? The numbers for new home and existing home sales do not show a surge comparable to these large earnings gains. How are JPM and Wells benefiting so much from the mortgage market?

The answer is probably HARP 2.0. Wells’ John Stumpf made a reference to “attractive financing rates.” As Stoller points out, HARP, the program opening refinancing even to underwater borrowers, accounted for 15% of Wells’ mortgage originations in the quarter (a refinance is in essence an origination), and with some of the barriers swept out in March, that should surge higher in the coming months. And because HARP 2.0 is a bad deal for borrowers, that’s particularly bad news:

The scheme was part of the Obama administration’s early response to the stagnant US housing market but it was overhauled last year to make qualification easier, removing a loan-to-value limit and giving participating lenders immunity from paying compensation on loans that broke underwriting guidelines.

Banks have seized on “Harp 2.0” as a highly profitable generator of new fees, according to lenders and analysts. John Stumpf, chief executive of Wells Fargo, told the Financial Times in February that Harp was “much more workable” in its new guise. Analysts expect $2bn-$4bn in additional revenue for Wells this year because of the programme. Wells and JPMorgan Chase, two of the three biggest mortgage servicers, both report earnings on Friday.

Borrowers with negative equity have largely been unable to shop around for finance because banks refinancing loans they already service enjoy the best terms in the government-sponsored scheme. That has led to mark-ups by banks refinancing their own borrowers that may lead to $12bn in additional revenue this year, according to analysts at Nomura [...]

“The largest banks are clearly taking advantage of the opportunity the government [unnecessarily] gave them,” said analysts at Amherst Securities in recent research.“In a competitive environment, we would expect some of the benefit to be passed on to the borrower. However, we are not in a competitive environment.”

Indeed, as I’ve pointed out, most lenders have restricted their refinancing under HARP 2.0 to customers they already deal with. That allows every mortgage lender to raise rates on trapped borrowers. A little break on refinancing is better than nothing, and borrowers will take it. But in the process, banks reap major fees and capture current homeowners at a higher interest rate than they could otherwise command in the marketplace.

Earnings reports always come with a lot of financial legerdemain, so it’s hard to draw a lot of conclusions. But you can take away one thing: banks have figured out how to use a government program to trap customers and make money. It’s what they do.