Will Taxpayers End Up Bailing Out Bank of America -- Again?
A financial industry pub recently named Bank of America's (BAC)'s Merrill Lynch unit as North America's "most innovative investment bank." It wasn't kidding. B of A has been shoveling derivatives out of Merrill into the part of the bank insured by the U.S. government, Bloomberg reports:
Three years after taxpayers rescued some of the biggest U.S. lenders, regulators are grappling with how to protect FDIC-insured bank accounts from risks generated by investment-banking operations. Bank of America, which got a $45 billion bailout during the financial crisis, had $1.04 trillion in deposits as of midyear, ranking it second among U.S. firms.
"The concern is that there is always an enormous temptation to dump the losers on the insured institution," said William Black, professor of economics and law at the University of Missouri-Kansas City and a former bank regulator.Guess who's now on the hook for Merrill's bets if they should suddenly crap out (hint: Not the house)? One key question is the value of the derivatives B of A moved. That's unclear, because the company won't say. Also uncertain is exactly what the securities consist of. Are they mostly "plain vanilla" instruments that, say, airlines use to protect themselves against a sudden hike in the cost of jet-fuel, or are they credit default swaps, collateralized debt obligations or other flammable materials?
Preparing the safety net
What we do know is that as of June 30 B of A's holding company had about $75 trillion worth of derivatives on its books (By comparison, U.S. GDP is roughly $15 trillion.) We also know that B of A is a company that fires its own loan fraud investigators for rooting out fraud. This is a dangerous mix.
What appears to have prompted the struggling financial giant, which was just eclipsed by JPMorgan Chase (JPM) as the nation's largest lender, was Moody's (MCO) move last month to lower its rating on B of A's senior debt. That spooked some of Merrill's financial counterparties, according to Bloomberg:
The Moody's downgrade spurred some of Merrill's partners to ask that contracts be moved to the retail unit, which has a higher credit rating, according to people familiar with the transactions. Transferring derivatives also can help the parent company minimize the collateral it must post on contracts and the potential costs to terminate trades after Moody's decision, said a person familiar with the matter.As Yves Smith notes, that amounts to transferring risk from Wall Street banks, hedge funds and other financial firms Merrill does business with to -- presto! -- American taxpayers. Call it a preemptive bailout. With visions of 2008 still seared into the national consciousness, not to mention the U.S. economy, it seems we are back to the future.
Compliant Fed
And where are the government guardians protecting the financial system? That is perhaps the most disturbing, if least surprising, aspect to the story. The Federal Reserve appears to have sanctioned B of A's legerdemain on grounds that it enhances the company's "safety and soundness." By contrast, the FDIC is worried, since the agency would have to pick up the tab if B of A ever failed. Bloomberg:
The bank doesn't believe regulatory approval is needed, said people with knowledge of its position.B of A is right -- being "too big to fail," it doesn't need government approval. This is a bank with more than $2 trillion in assets and $1 trillion in deposits. As of the second quarter, the FDIC's deposit-insurance fund had less than $4 billion. The regulator couldn't cover B of A depositors if it wanted to. As a result, the Fed seems determined to arrange another line of credit courtesy of Uncle Sam. Writes Black, among the most trenchant critics of the U.S. financial system:
[Bank of America's] request to transfer the problem derivatives to B of A was a no brainer -- unfortunately, it was apparently addressed to officials at the Fed who meet that description. Any competent regulator would have said: "No, Hell NO!"One of the Occupy Wall Street movement's chief complaints is that big financial firms and the feds are joined at the balance sheet. And in fact, this was one of the defining lessons of the financial crisis -- in this marriage of convenience, private losses must be socialized in order to keep the economy from ripping apart at the seams. The "free market" is, in effect, rigged to favor the interests of large financial institutions at the expense of everyone else. That's the sort of "innovation" we can do without.
Thumbnail by Scott Ehardt via Wikimedia Commons
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