The Federal Reserve and Bank of America Initiate a Coup to Dump Billions of Dollars of Losses on the American Taxpayer

Bloomberg reports that Bank of America is dumping derivatives onto a subsidiary which is insured by the government – i.e. taxpayers.

Yves Smith notes:

If you have any doubt that Bank of America is going down, this development should settle it …. Both [professor of economics and law, and former head S&L prosecutor] Bill Black (who I interviewed just now) and I see this as a desperate move by Bank of America’s management, a de facto admission that they know the bank is in serious trouble.

The short form via Bloomberg:

Bank of America Corp. (BAC), hit by a credit downgrade last month, has moved derivatives from its Merrill Lynch unit to a subsidiary flush with insured deposits, according to people with direct knowledge of the situation…

Bank of America’s holding company — the parent of both the retail bank and the Merrill Lynch securities unit — held almost $75 trillion of derivatives at the end of June, according to data compiled by the OCC. About $53 trillion, or 71 percent, were within Bank of America NA, according to the data, which represent the notional values of the trades.

That compares with JPMorgan’s deposit-taking entity, JPMorgan Chase Bank NA, which contained 99 percent of the New York-based firm’s $79 trillion of notional derivatives, the OCC data show.

Now you would expect this move to be driven by adverse selection, that it, that BofA would move its WORST derivatives, that is, the ones that were riskiest or otherwise had high collateral posting requirements, to the sub. Bill Black confirmed that even though the details were sketchy, this is precisely what took place.

And remember, as we have indicated, there are some “derivatives” that should be eliminated, period. We’ve written repeatedly about credit default swaps, which have virtually no legitimate economic uses (no one was complaining about the illiquidity of corporate bonds prior to the introduction of CDS; this was not a perceived need among investors). They are an inherently defective product, since there is no way to margin adequately for “jump to default” risk and have the product be viable economically. CDS are systematically underpriced insurance, with insurers guaranteed to go bust periodically, as AIG and the monolines demonstrated. [Background.]

The reason that commentators like Chris Whalen were relatively sanguine about Bank of America likely becoming insolvent as a result of eventual mortgage and other litigation losses is that it would be a holding company bankruptcy. The operating units, most importantly, the banks, would not be affected and could be spun out to a new entity or sold. Shareholders would be wiped out and holding company creditors (most important, bondholders) would take a hit by having their debt haircut and partly converted to equity.

This changes the picture completely. This move reflects either criminal incompetence or abject corruption by the Fed. Even though I’ve expressed my doubts as to whether Dodd Frank resolutions will work, dumping derivatives into depositaries pretty much guarantees a Dodd Frank resolution will fail. Remember the effect of the 2005 bankruptcy law revisions: derivatives counterparties are first in line, they get to grab assets first and leave everyone else to scramble for crumbs. [Background.] So this move amounts to a direct transfer from derivatives counterparties of Merrill to the taxpayer, via the FDIC, which would have to make depositors whole after derivatives counterparties grabbed collateral. It’s well nigh impossible to have an orderly wind down in this scenario. You have a derivatives counterparty land grab and an abrupt insolvency. Lehman failed over a weekend after JP Morgan grabbed collateral.

But it’s even worse than that. During the savings & loan crisis, the FDIC did not have enough in deposit insurance receipts to pay for the Resolution Trust Corporation wind-down vehicle. It had to get more funding from Congress. This move paves the way for another TARP-style shakedown of taxpayers, this time to save depositors. No Congressman would dare vote against that. This move is Machiavellian, and just plain evil.

The FDIC is understandably ripshit. Again from Bloomberg:

The Federal Reserve and Federal Deposit Insurance Corp. disagree over the transfers, which are being requested by counterparties, said the people, who asked to remain anonymous because they weren’t authorized to speak publicly. The Fed has signaled that it favors moving the derivatives to give relief to the bank holding company, while the FDIC, which would have to pay off depositors in the event of a bank failure, is objecting, said the people. The bank doesn’t believe regulatory approval is needed, said people with knowledge of its position.

Well OF COURSE BofA is gonna try to take the position this is kosher, but the FDIC can and must reject this brazen move. But this is a bit of a fait accompli,and I have NO doubt BofA and the craven, corrupt Fed will argue that moving the derivatives back will upset the markets. Well too bad, maybe it’s time banks learn they can no longer run roughshod over regulators. And if BofA is at that much risk that it can’t survive undoing this brazen move, that would seem to be prima facie evidence that a Dodd Frank resolution is in order.

Bill Black said that the Bloomberg editors toned down his remarks considerably. He said, “Any competent regulator would respond: “No, Hell NO!” It’s time that the public also say no, and loudly, to this new scheme to loot taxpayers and save a criminally destructive bank.

Professor Black provided a “bottom line” summary in a separate email:

1.The bank holding company (BAC) is moving troubled assets held by an entity not insured by the public (Merrill Lynch)  to the Bank of America, which is insured by the public
2. The banking rules are designed to prevent that because they are designed to protect the FDIC insurance fund (which the Treasury guarantees)
3. Any marginally competent regulator would say “No, Hell NO!”
4. The Fed, reportedly, is saying “Sure, no worries” by allowing the sale of an affiliate’s troubled assets to B of A
5. This is a really good “natural experiment” that allows us to test whether the Fed is protects the public or the uninsured and systemically dangerous institutions (the bank holding companies (BHCs))
6. We are all shocked, shocked [sarcasm] that Bernanke responded to the experiment by choosing to protect the BHC at the expense of the public.

Karl Denninger writes:

So let’s see what we have here.

Bank customer initiates a swap position with Bank.  In doing so they intentionally accept the credit risk of the institution they trade with.

Later they get antsy about perhaps not getting paid.  Bank then shifts that risk to a place where people who deposited their money and had no part of this transaction wind up backstopping it.

This effectively makes the depositor the “guarantor” of the swap ex-post-facto.

That the regulators are allowing this is an outrage.

If you’re a Bank of America customer and continue to be one you deserve whatever you get down the line, whether it comes in the form of higher fees and costs assessed upon you or something worse.

Stand Up to the Coup

Bank of America has repeatedly become insolvent due to fraud and risky bets, and repeatedly been bailed out by the government and American people. The government and banks are engineering an age of permanent bailouts for this insolvent, criminal bank (and the other too big to fails).  Remember, this is the same bank that is refusing to let people close their accounts.

This is yet another joint effort by Washington and Wall Street to screw the American people, and to trample on the rule of law.

The American people will be stuck in nightmare of a never-ending depression (yes, we are currently in a depression) and fascism (or socialism, if you prefer that term) unless we stand up to the overly-powerful Fed and the too big to fail banks.

Category: Bailouts, Derivatives, Federal Reserve, Think Tank

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

17 Responses to “Fed & BofA Dump Billions in Losses onto Taxpayers”

  1. BusSchDean says:

    Another example of the apparent trade-off between maintaining the integrity of the market system and preventing more layoffs. The TBTF shadow continues to loom large. Since we did not follow the Swedes in protecting the system at the expense of the banks the course we chart will inevitably include TBTF corporations.

  2. MayorQuimby says:

    Keep supporting those banks suckas.

  3. prozach says:

    If what they say is true (and I have no reason to doubt it is), can’t the FDIC just publicly say:

    “Go ahead, transfer the assets, your insurance is void and your deposits are no longer covered.” (or whatever the equivalent is in FDIC terms)

    And be done with it one way or another?

  4. Greg0658 says:

    for the kids .. Stan deposits $100 and:
    South Park – Poof its gone (27sec)
    http://www.youtube.com/watch?v=RAKsMnAM8vk

  5. Futuredome says:

    Sorry, but once again………all these leads toward a government takeover of BA. Period. Your going to pay no matter what. TARP? Forget about it. That bought a little more time but the buzzer sounded.

    Your going to pay for the depositers, that, is a done deal. But BA corp will be dissolved.

  6. [...] Fed and BofA dumping billions in derivative losses on a taxpayer-supported entity.  (TBP) [...]

  7. Finster says:

    As the holding and the retail bank are not identical entities, this amounts to a contract to the detriment of a 3rd party. These tend to be illegal in most legal systems. The 3rd party is not being compensated for this. Even though the holding has control of the retail bank, I’m not sure this move does not constitute a breach of trust.

    Intersting how quickly we lose sight of simple legal principals when it comes to banking?

  8. Sportello says:

    I would like to know which Merrill Lynch affiliate was used for booking the swaps. They could not have been with the broker-dealer, as it would have destroyed the balance sheet.

    Booking swaps into a bank is traditional (though not to say that it’s a good idea), as they have the balance sheet to support these kinds of trades. Mark-t0-market margin would require the bank to post collateral as needed, so there shouldn’t be any big surprises. And the banks would still need to respect deposit reserve requirements, regardless of how the customers deposits are used — whether to make new loans or as collateral for swaps.

    This could all be part of a normal consolidation of business practices, e.g., all swaps for the institution should be booked with the bank. But I wonder if BAC might be pruning ML in advance of a sale. That would be good for ML and for BAC (provided the sale was done well).

    I’m no fan of BAC — I think their insolvent, stupid and greedy — but it seems like there is more to the story going on here.

  9. theexpertisin says:

    Wow. Excellent article on this situation.

    I think your observation on a sale of ML is spot on, as BAC attempts to rid itself of poor paper and downsize itself. Long term, a good thing for BAC shareholders.

  10. klhoughton says:

    prozach – We can call that the “Jimmy Stewart Hollymoon Cancellation Scenario,” right?

  11. [...] Fed & BofA Dump Billions in Losses onto Taxpayers (ritholtz.com) [...]

  12. efg says:

    The issue identified is B0fA moving CDS’s into subsidiaries with FDIC insured deposits as a way to remove pressure for asset demands by counter-parties and / or to put additional pressure on the Fed and congress for a future bailout when the need arise. The result being another transfer of responsibility for bad investments and bad decisions by bankers from bankers to the taxpayer.

    Possibly, we should not wait for the government and its agencies. Possibly we should go back to Jimmy Stewart, but in reverse. For example, the OWS could publicize this as another example of WS corruption AND regulatory capture and promote the idea that supporters move their deposits elsewhere. This may certainly accelerate BofA’s issues, but would also highlight that this type of practice will no longer be tolerated. All it would take is some good press coverage and some initial withdrawals / lines t withdraw.

    This could be a ripe example for their grass roots movement.

  13. None of this is surprising to anyone who took a look at the General Accountability Office’s report on Fed governance. This despite the fact that the GAO failed (purposefully?) to make the crucial connections between the various issues it identified: http://bit.ly/qi8dNW

  14. Francois says:

    The Fed is OK with saving the bacon of a bank, no matter what it cost to the taxpayers?

    Shocking! Woulda never thought this possible.

    Now, if I remember correctly, the actual Chairman of the Fed was confirmed with the lowest number of “Yays” in US History.

    Furthermore, many people close to this saga confirmed that Brotha Obysmal twisted quite a few arms to make sure that BurntWinkie would be confirmed.

    Hmmmm!

    The actual occupant of the WH is really a stooge for the banksters, ain’t he?

  15. fulredy says:

    $53 trillion!! That can’t be right, is it?

  16. “…Stand Up to the Coup

    Bank of America has repeatedly become insolvent due to fraud and risky bets, and repeatedly been bailed out by the government and American people. The government and banks are engineering an age of permanent bailouts for this insolvent, criminal bank (and the other too big to fails). Remember, this is the same bank that is refusing to let people close their accounts.

    This is yet another joint effort by Washington and Wall Street to screw the American people, and to trample on the rule of law.

    The American people will be stuck in nightmare of a never-ending depression (yes, we are currently in a depression) and fascism (or socialism, if you prefer that term) unless we stand up to the overly-powerful Fed and the too big to fail banks….”
    –from above..

    more succinctly..

    “Stand Up to the Coup” !

    “This is yet another joint effort by Washington and Wall Street to screw the American people, and to trample on the rule of law.”

    “The American people will be stuck in nightmare of a never-ending depression (yes, we are currently in a depression) and Fascism unless we stand up to the overly-powerful Fed and the too big to fail banks….”
    ~~

    Francois,

    to your Query..

    see some of.. http://search.yippy.com/search?query=The+Obama+Deception&tb=sitesearch-all&v%3Aproject=clusty

    A. Jones is not ‘perfect’, though, He delineates, well, the Case of #44 ..

  17. WallaWalla says:

    As disturbing as this is, there are other aspects of this story.

    Warren Buffet’s Berkshire Hathaway investment of 5 billion dollars at an exceedingly generous 6% per annum interest rate makes me increasingly uncertain. Demanding such a high interest rate is likely because BAC is indeed on the brink. To make matters worse, Buffet was in private closed door meetings with obama in the days before the investment (YIKES, can we please please please get some transparency here). Buffet only invests in companies with a Durable Competitive Advantage. Without an absolute guarantee of government backing, BAC has absolutely none of the attributes that give a company DCA.

    My hunch is that that BAC is, like you say, closer to the edge than most people realize. To kick the can a bit further down the road, Obama convinced Buffet to invest in BAC to keep them solvent… until the next election at least. He did this by reassuring Buffet that the gov’t would step in and bailout the behemoth if need be. All in the name of ‘job creation,’ i.e. Obama needs to create his job for the next term.