If you needed something else to keep you awake over the Halloween season, this one should be good for months of sleeplessness. Over the night between Monday and Tuesday, the Federal Reserve and Bank of America agreed to move their derivatives from an uninsured part of their organization (the old Merrill-Lynch unit) to a part of their organization that is insured. Thus the risk for losses incurred by Bank of America has been moved the stockholders of BofA to the Federal Deposit Insurance Corporation . I am sure most of you are aware that the eventual insurer of last resort in this case will be you and I
Think about this for a minute. Now in the case of a bank failure due to derivative failure the losses will not be covered by those owning stocks and bonds in BofA as it should be. The losses will be covered by the FDIC which in turn gets its money from the banks around the country which in turn gets its money from its depositors – you and me.
I will admit that I have possibly not done an adequate job of explaining the situation. Bloomberg News has a good explanation here:
“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.
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.
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. “We should have fairly tight restrictions on that.”
I strongly recommend that you read the whole Bloomberg article along with a couple of analysis pieces that really flesh out the details. The first is from zerohedge which has these two scary paragraphs:
“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.”
Over at Dailykos, Marie notes:
“The “genius” of Bernanke and Geithner appears to be that they kicked part of what they called a liquidity crisis can down the road and into the FDIC house. Now, instead of TARP II and/or more FED bailouts, the FDIC will be the insurer and loss-payer. That spreads the costs of the risk right down into the pockets of every federally insured customer of a financial institution. How that works is the FDIC raises its rates to it’s members and they in turn pass along the increased costs to customers.
It’s been a capital crisis since the housing bubble began to pop. A question that nobody wanted answered was how deep the hole was. A second question was how to stick it to the 99%. A question we should be asking is why the credit rating bureaus waited until now to downgrade and the counterparties silently bided their time. It’s not as if those derivatives are significantly more impaired today than they were last year. Is it too ludicrous to mention that last year there were two women familiar to dKos readers standing in the way of more dead-of-night deals for the 1%? Elizabeth Warren and Sheila Bair, Chairperson of the FDIC until July 8, 2011. The wrong two people were most definitely let go.”
The short analysis is that the monied interests (counterparties) have once again privatized gains and socialized their losses in a big way. Is it legal? Maybe, maybe not, but it has been done and I doubt it will be undone since they servants of those monied interests (the Republican Party) have been and are now in positions to limit any action that would harm their masters.
This is EXACTLY what OWS is about. The 1% has once again robbed the 99%. Yet, the news of this has been buried as far as I can tell. While I do not listen to news nearly as much as I used to I still have not heard anything abut it on the general media.