Paging Andrew Stuttaford! This seems bad to me:
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.
Unless I’m reading this wrong, that looks like a more or less direct transfer of risk from B of A to the American public through the FDIC.
How much risk? Oh, dear:
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.
Of course the FDIC insures deposits, so we’d only be on the hook for that, not for the derivatives. What concerns me is that B of A apparently is operating under an exemption from regular rules:
As a general rule, as long as transactions involve high- quality assets and don’t exceed certain quantitative limitations, they should be allowed under the Federal Reserve Act, Omarova said.
In 2009, the Fed granted Section 23A exemptions to the banking arms of Ally Financial Inc., HSBC Holdings Plc, Fifth Third Bancorp, ING Groep NV, General Electric Co., Northern Trust Corp., CIT Group Inc., Morgan Stanley and Goldman Sachs Group Inc., among others, according to letters posted on the Fed’s website.
The central bank terminated exemptions last year for retail-banking units of JPMorgan, Citigroup, Barclays Plc, Royal Bank of Scotland Plc and Deutsche Bank AG. The Fed also ended an exemption for Bank of America in March 2010 and in September of that year approved a new one.
Am I missing something, or does this mean that the government is now at least partly backstopping B of A against these derivatives? Stuttaford? If I’m out of my tree on this one, let me know in the comments.
I'd just like to point out that you could be correct, and *still* be out of your tree.
Just saying.
Reply to this commentLinkReport AbuseNo way should we ever, ever, ever regulate the derivatives market. All regulations are bad -- it's always better to allow the banks to self-regulate.
Reply to this commentLinkReport AbuseThis isn't about regulation. This is about an insurer's right to control what it insures.
Reply to this commentLinkReport AbuseWould it really be overly onerous to establish a rule (or law) saying something like "No US corporation may expose itself to financial risks whose total downside is greater than the national GDP"?
I don't think the costs of compliance would be too high (it's not exactly Byzantine; it can be stated in one sentence).
And it seems like common sense to me that there is monkey business afoot when a corporation is risking 75 trillion... when that company's market cap is 65 billion and and its enterprise value is estimated at 205 billion. And when it is doing its business in a nation whose GDP is between 14-15 trillion.
Reply to this commentLinkReport AbuseNope, that would be overly onerous. A law such as the one you mention would be the equivalent to class warfare, and would represent government intrusion into the sanctified hollows of private enterprise.
The free market will regulate itself. The banks are job creators. If they can keep on pulling in huge bonuses, they can funnel even more of that money to candidates like Romney, who can then help his GOP buddies in congress block the CFPB. That way the banks can keep on making profits. If they need a bailout every once in a while, it's only because the govt. intruded in the first place by making them make loans to poor people.
Also, this is the kind of thing that motivates those OWS hippies. And as we know from the Corner's posts on the subject, those people are communists and need to redirect their attention away from Wall Street, because Wall Street never does anything that creates moral hazard or systemic financial risk.
Reply to this commentLinkReport AbuseAnd how was this ever allowed to happen? By the govt of course. Through Fannie and Freddie and the CRA and through deals they got from regulators as payoffs to not make too much of a fuss. Let me clarify, by both political parties - not just your beloved GOP. And which party made at least some attempt to say, wait a minute we have a problem? Yes, those heartless GOP types. And who said no, everything is fine, while they took kickbacks from businesses like Countrywide Financial? Why it was the democrats. Amazing.
Corporations are pretty much non-political. The govt is an entirely different story. Without those GSAs this NEVER could have happened. Why aren't the OWS folks recognizing that. No, they just want to be crony capitalists too. See Moe, unlike you, I see very little difference between a reckless corp or a reckless govt official. The problem, the recklass govt gets to forcibly take my money. So I would love you to be a little more worried about what your friends in Washington are doing. Without the evil corporations and the people they employ, where o where will the govt get its funds to do all the nice wonderful things you feel the govt should hand out to people.
Reply to this commentLinkReport AbuseThat 75 trillion number is impressive and scary, but it has nothing to do with the amount of money actually at risk. One of the most common derivative contracts is an interest rate swap, for example. This derivative is used to hedge risks on floating interest rates. The notional amount is analogous to the principal of the loan, but the actual risk relies upon fluctuations in the interest rate. Commodity swaps such as oil have similarly massive notional valuations while their actual risk is orders of magnitude lower. The number also doesn't take into account offsetting positions.
Reply to this commentLinkReport AbuseWhy not bail them out again? According to GOP alternate-history, Wall Street was forced into derivatives exposure because librul fascists held a gun to their head and forced them to make home loans to black people.
Also, those OWS hippies are commies, or something.
News like this is why OWS is twice as popular to the Tea Party. Congratulations for partially realizing how the banks are robbing this country blind, and using the spoils to lobby for less regulation on one hand and bailouts on the other. Don't wander too far off the reservation though. Keep in mind, the banks are "job creators." LOL!
Reply to this commentLinkReport Abuse"According to GOP alternate-history, Wall Street was forced into derivatives exposure because librul fascists held a gun to their head and forced them to make home loans to black people."
They were.
They then discovered that the derivatives they'd invented as a hedge against what they'd been forced to do, could be used to juice their earnings (and bonuses). So they did, and went crazy. And then Fannie and Freddie joined in the craziness and (being huge and government backed) vastly multiplied it, turning what would have been a garden-variety boom-bust cycle into a full-bore global financial crisis.
One last challenge to prove you're a serious person: Rebut this.
(Trademark sarcasm allowed, but only after rebuttal on the facts actually accomplished.)
Reply to this commentLinkReport AbuseNo, they weren't forced. Guys like Paulson and Bernanke had been lobbying for years to loosen standards to let them get more and more leveraged and to make more and more loans. The banks were fully in on getting the Fed to lower interest rates, in getting the ratings agencies to give their bad loans good ratings, and in creating a revolving-door where regulators constantly moved between the banks and the SEC. The more loans they could make, the more interest they could collect from more sectors of the economy, and the bigger bonuses they could get. That's a deal they were happy to take.
I don't get it. We have no problem acknowledging that Solyndra was responsible for ripping off the taxpayer in collusion with the government. Nobody argues that Solyndra was "forced" to take bad loans that happened to make some people who invested in it very rich. So why do we do this with the banks?
Our whole banking system with the Federal Reserve, where we've created a central bank with essentially government powers, which can create and redistribute money and works closely with other banks, is socialist, even if the banks are nominally private. The whole thing is Solyndra writ large.
Reply to this commentLinkReport Abuse"News like this is why OWS is twice as popular to the Tea Party."
Which is odd (or, actually, a function of a favorably-worded poll), since the Tea Party was against bailouts before the OWS guys were a glimmer in Karl Marx's ghost's eye.
Reply to this commentLinkReport AbusePut forth an "OWS Candidate". Other than Obama, that is.
Sit back and enjoy the [failed] results.
You are delusional.
Reply to this commentLinkReport AbuseThis is correct- interestingly redstate another conservative website has seen the writing on the wall and is making conciliatory position regarding OWS given OWS popularity is now, as you say, far greater than the tea partiers. The Corner hasnt quite realized this yet, but i expect to see more conciliatory postings here in the coming days weeks as they realize that OWS has touched a raw nerve amoung americans.
In the mean time the dismissive postings about OWS on NRO (hippies etc) are becoming increasingly brittle.
Reply to this commentLinkReport AbuseAs someone who has had a long career in derivatives, let me just say that these notional values attributed to contracts are useless. Further, I suspect the numbers where misreported on several levels. Likely expired contracts are added together to get some annual figure, both sides of a swap a maximally valued, etc. You can print almost anything with respect to derivatives since so few people understand them.
One last thing: the AIG swaps were understood by all parties involved that there was counterparty risk. Why the US government made (largely) German banks whole for this nonsense has never been explained. So in the end, if the government wants to write a check, then it doesn't matter in what part of Bank of America the contracts reside.
Reply to this commentLinkReport AbuseNotional amount, not value. But you knew that.
Shhhh. If people could figure this stuff out, they'd kill us.
Reply to this commentLinkReport Abuse"You can print almost anything with respect to derivatives since so few people understand them."
Including the people who writeand trade them.
Reply to this commentLinkReport Abuse"Including the people who write and trade them."
You're confusing 'not understanding' with 'not caring.' Because when you have millions to head home to, and are practically immune from prosecution for your actions, why not take unbelievably risky gambles that could harm everyone in the nation? Why not grab every single thing you possibly can, smirking all the way at everyone else?
Reply to this commentLinkReport AbuseHeinlein's Law. Malice vs. stupidity, etc.
As much as I'd like to take comfort in this just being a function of bankers being evil, after having hollered "Bubble!" in countless arguments since at least 2003 with people who didn't have any financial interest in denying one was developing, I have to go with "stupid."
Or, more properly, "so hyperspecialized that they couldn't see the big picture." Because a lot of these people -- including some fairly big names -- are not stupid, and on balance are probably smarter than I am. But I think they've fallen into our excessively schooled civilization's increasing habit of following the habits learned in school -- follow directions, apply the formula, trust credentialed experts, and grind away in the groove.
The formula said the odds and extent of a national decline in housing prices was low. So people plugged the formula into their transactions, and chugged along. If they wondered about those stories in the doomsaying bubblehead blogs about strawberry pickers taking out half-million-dollar no-doc mortgages, they figured they were anomalies. The experts didn't worry, so why should they?
I genuinely think that the banks didn't understand just how thoroughly the entire western United States had engaged in across-the-board mortgage fraud.
Stupidity, not malice. That terrifies me. Malice we can forbid and hopefully deter with threat of punishment. Stupidity doesn't even know when it's being stupid, and so can't be deterred.
Reply to this commentLinkReport AbuseYea, totalling up both sides of the coin is a fallacious way to calculate exposure. You have to take into account the net "direction" of the derivatives and not just the nominal value/exposure of the derivative.
For a simplistic analogy in the equity domain, if I buy 50 shares of BoA and short 50 shares of BoA at the same time my net exposure is zero, I can't make or lose money. Yet you could say I have bet 100 shares on the future of BoA.
That being said, I fundamentally disagree with allowing banks to shift exposure to the FDIC and thus taxpayers through accounting gimmicks.
The reason we have the FDIC is in the first place is to ensure confidence in the banking system. Moreover, it is a system that allows a bank to fail without jeopardizing the community the bank fails in. It's community bank roots do not translate into the modern financially system of leverage, derivatives, and balance sheets as large as national GDPs.
The existence of the FDIC guarantee was also supposed to limit what amount of risk the bank was allowed to take on. That is why you have other forms of deposits that supposedly gave higher returns, incurred more risk, and generated higher returns without a government guarantee (money market funds, mutual funds, etc.) But now even money market funds are government backstopped. I guess I am just not as smart as our dear leaders in Washington.
Crony capitalism is all this is in the end. Private gain, public risk, campaign donations make the world go round these day.
Reply to this commentLinkReport AbuseTotaling notionals has even greater flaws than ignoring offsetting positions. If I take out an interest rate swap to lock in a floating rate on, say a 100 million loan, my notional for that trade is 100 million. But the swap payments are determined by fluctuations in the interest rate, which are generally measured in basis points (1/100 th of a percentage point). So my real exposure is on the order of 1 million (depending of course on myriad factors, but the point is it's no where near the notional).
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