Bank of America Deathwatch: Moves Risky Derivatives - TheNewTopical.com - current events, politics, culture, ethics, economics discussion forum

FredFredson · #1 (**permalink**) 22-10-11, 04:03 AM

Bank of America Deathwatch: Moves Risky Derivatives from Holding Company to Taxpayer-Backstopped Depositors
by Yves Smith - Naked Capitalism

If you have any doubt that Bank of America is in trouble, this development should settle it. I’m late to this important story broken this morning by Bob Ivry of Bloomberg, but both Bill Black (who I interviewed just now) and I see this as a desperate (or at the very best, remarkably inept) move by
Bank of America’s management.

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 is, 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.

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. 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 Fed will argue that moving the risker 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 afford to undo moving over unacceptably risky exposures measure, 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 yet another route for running a drip feed from taxpayers to banksters.

Update: Brett in comments raise the question that since JP Morgan books virtually all of its derivatives in a depositary, is this really all that sus?

The short answer is that while this on paper looks similar, in fact the JPM derivatives exposures (and those of the other big banks) are pretty different than those of Merrill. The big commercial banks traditionally were the big players in plain vanilla, low margin derivatives, specifically interest rate and FX swaps. They are ALSO in credit default swaps, so there is no denying that there are risky derivatives included in the mix.

JPM runs a massive derivatives clearing operation, and a lot of its exposure relates to that. This and the businesses of the other large banks have been supervised by the regulators for some time (you can argue the supervision was not so hot, but at least they have a dim idea of what is going on and gather data). By contrast, no one was supervising the derivatives book at Merrill. The Fed long ago gave up supervising Treasury dealers, and the SEC does not do any meaningful oversight of derivatives. And Chris Whalen confirms that Merrill was and is the cowboy among derivatives dealers.

You can argue that this is just normal business, the other big banks have their derivatives operations largely in the depositary. But BofA has owned Merrill for over a year and a half, and didn’t undertake this move until it was downgraded. Goldman and Morgan Stanley reamin big players in this business and don’t have a large depositary. If this was all normal business, BofA would have done this a while ago, and not in response to market pressure, and they would have gotten the FDIC on board. The way this was done says something is amiss.

FredFredson · #2 (**permalink**) 22-10-11, 04:14 AM

EU bank failures will crash Wall Street — again
by Paul B. Farrell - MarketWatch

8 warnings for Washington and Occupiers
Worst-case scenario’s closing fast: Occupy Wall Street growing. But no political power or allies yet. Feared yes, attacked by GOP proxy tea party. Soon the Occupation will explode into a new American Revolution. When? A string of European bank collapses is dead ahead. And like the Arab Spring, they will trigger an economic disaster for American banks.

Yes, coming soon says Martin Weiss in his “7 Major Advance Warnings,” which is “bound to have a life-changing impact on nearly all investors in the U.S. and around the globe.” His new Weiss Ratings warnings are the “most important” in a 40-year career. The stress on Wall Street banks will force them back to Congress for more bailouts. Warning eight: No new bailouts. That will push the economy into a deep recession.

Then what? New Glass-Steagall? Not enough. Tax the rich? Not enough. Perp walks? Not enough. Presidential commission? Useless promises. Occupy Wall Street will fail without a fundamental constitutional change. No compromise. Or Wall Street wins, again. We go back to the same free market, deregulated, too-greedy to-fail, conservative Reaganomics policies that have been destroying democracy for a generation.

All this was so obvious, so predictable. America is at a crossroads. Occupy Wall Street buildup has emerged as America’s last great hope to restore democracy. Last week when USA Today called the Occupiers a “ragtag assortment of college kids, labor unionists, conspiracy theorists and others” hinting they’re a flash-in-the-pan “devoid of remedies,” I smiled, reminded of that famous painting of George Washington crossing the Delaware on Christmas 1776, leading what historians also called a “ragtag” Continental Army, surprising the British, and winning the Battle of Trenton.

America’s collective conscience wants true democracy restored
Yes, USA Today sees a “ragtag” army: No mission, no goals, no organization, no agenda, no leaders, and no staying power. Wrong. Look deeper: The Occupiers are the voice of America’s collective conscience demanding a return to our 1776 roots, to a “government of the people, by the people, for the people.”

Our collective inner voice knows America’s moral compass is broken. We’ve become a government “of, by and for” special interests, the wealthiest 1%, Wall Street insiders, CEOs and Forbes-400 billionaires. It happened fast: In one generation the Super Rich grabbed “absolute power,” killing the middle class American dream.

Wall Street banks are already dismissing the Occupiers … planning bigger bonuses this year… lifting limits on their license to gamble Main Street deposits in the $600 trillion global derivatives casino … they already spend hundreds of millions lobbying every year … they’re convinced they can defeat the Occupiers with campaign donations in the back rooms of Congress … writing off the fight as another business expense … ultimately expecting the Occupiers will vanish into the cold winter months.

One citizen. One dollar. One vote. Anything less is failure
Warning: Don’t be fooled. Occupy Wall Street knows exactly want it wants. The tea party, GOP’s proxy, isn’t fooled. They feel threatened, counter-attacking, worried their role will be lost in the 2012 elections, fearful they’ll lose sway over Republicans, so they’ve got a smear campaign against Occupy Wall Street. Won’t work:

Amid all the noise surrounding Occupy Wall Street we hear their “one simple demand.” Missed by most outsiders, that demand echoes down through American history, first heard in 1776 in the Declaration of Independence. Earlier the Occupiers voiced their one simple demand:

“We demand that integrity be restored to our elections. One citizen. One dollar. One vote. Only citizens should make campaign contributions. Campaign contributions by citizens should not exceed $1 to any political candidate or party. Help us reclaim democracy.”

Yes, one simple demand: “Stop the monied corruption at the heart of our democracy.” That one simple demand echoed over and over. And no compromise when dealing with so fundamental a principle of democracy. Compromises the last generation surrendered America to Wall Street and the Super Rich. Compromise this principle again, and we all lose, destroy America. No compromise. Period.

Phase 2: EU bank collapse gives Occupiers new political power
The Occupiers Revolution enters a new phase soon: First Arab Spring rippled into American Fall. Next, EU bank collapses will ripple through Wall Street. For a long time we’ve been warning the 2008 meltdown never ran its course, foiled by mega-bailouts … bankers never shared the sacrifice … fought all reforms … are back to business-as-usual … learned no lessons … now even more delusional, expecting bigger bonuses … trapped in denial for three years … cannot see what’s ahead … a perfect setup for a bigger crash.

That’s why my eye locked on Martin Weiss’ “7 Major Advance Warnings.” Weiss has been a champion of the little guy for 40 years, author of “The Ultimate Money Guide for Bubbles, Busts, Recession and Depression.” Weiss Ratings of domestic and foreign debt markets downgraded U.S. debt before the S&P.

Both of us were warning well in advance of the 2008 crash. It was so predictable: Weiss warned of “failure of Bear Stearns Lehman, Washington Mutual, near-failure of Citigroup and the demise of Fannie Mae years before it collapsed.”

So listen closely to his “7 Major Advance Warnings,” which are “the most important in the 40-year history of my company.” Many will dismiss them, distracted by today’s campaign noise. Others will dismiss them as “over there,” problems for Europeans. Weiss warns: EU banks problems are “bound to have a life-changing impact on nearly all investors in the U.S. and around the globe.”

So listen and discount what Wall Street is selling you. Protect your portfolio. Here are edited highlights:

Greece will default very soon ...
”Banks must bite the bullet and take some big hits in their Greek loans. … Whether banks accept this ‘solution’ voluntarily or not, it will mean Greece is in default.”

The contagion of fear will spread …
Global investors know “if one major Western government can default, so can others.” They will refuse to lend “to highly indebted governments” or “demand outrageously high yields.”

European megabanks will collapse …
Some of the “largest banks will collapse under the weight of defaulting sovereign debts and … mass withdrawals … Spain … French banks” … the impact will ripple across “J.P. Morgan Chase, Bank of America and Citigroup … All three are in danger.”

EU governments suffer new credit rating downgrades ...
”France and Germany, will scramble to rescue their failing banks.” But “bank bailouts are seriously flawed” as “governments gut their own fiscal balance … suffer big downgrades,” or pay “far higher interest rates.”

Spain and Italy next to face default on their massive debts ...
With “$3.4 trillion in debt, or about 10 times more than Greece” they too risk default.

Global debt markets will suffer a critical meltdown ...
Anticipating “default by a country as large as Spain or Italy, nearly all debt markets in the world will freeze.” Withdrawals, panic “not only crush the borrowing power of the PIIGS” but threaten meltdowns in “France, Germany, Japan, the U.K. and the U.S.”

Vicious cycle: sovereign defaults, bank failures, global depression ...
Government defaults trigger more bank failures, “cut off the flow of credit to businesses and households, sink the global economy into a depression, and perpetuate the vicious cycle.”

Warning to investors: No bank bailouts, power to Occupation
History inevitably repeats itself: Arab Spring triggered Wall Street Fall. Next, the raging European monetary collapse will ripple through America’s banking system, completing the 2008 meltdown that never ended because Wall Street fought all reforms. But now, a bigger meltdown as history repeats a dangerous cycle like the 1929 Crash and Great Depression.

History will also deal a fatal blow to Wall Street. Weiss adds a key warning: No bank bailouts. America’s banking system is bankrupt, structurally and morally. Washington is broken. And thanks to the Occupiers Revolution the masses will never accept new bank bailouts. Never. They’ll toss politicians and overthrow government first.

No new bailouts will be the stake in the heart of Wall Street, ending the “greed is good” power of America’s “bloodsucking vampire squid,” handing the Occupiers new political power in Washington.

Weiss’s worst-case scenario highlights everything we’ve both been warning investors about for a long time. The 2008 meltdown never ended, lessons never learned. But now the end game is accelerating.

Listen closely: Weiss final warning to all investors: “Get all or most of your money out of danger immediately … above all, stay safe!” Prepare for the coming bank collapse. And discover how this historic scenario will empower the Occupiers message to get money out of elections: “One citizen. One dollar. One vote.” Compromise on that principle and Wall Street wins, again.

FredFredson · #3 (**permalink**) 22-10-11, 04:40 AM

A leveraged EFSF is pure poison
by Ambrose Evans-Pritchard - Telegraph

Big snag. If Europe’s leaders do indeed leverage their €440bn bail-out fund (EFSF) to €2 trillion or €3 trillion through some form of "first loss" insurance on Club Med bonds – as markets now seem to assume – the consequences will be swift and brutal.

Professor Ansgar Belke, from Berlin's DIW Institute, said any leveraging of the EFSF would be "poisonous" for France’s AAA rating and would set off an uncontrollable chain of events. "It counteracts all efforts made so far to stabilize the eurozone debt crisis, which are premised on the AAA rating of a sufficiently large number of strong economies. In extremis, it would probably cause the break-up of the eurozone", he told Handlesblatt.

France is already vulnerable. It has the worst budget deficit and primary deficit of the AAA states in Euroland. (Yes, Britain is worse, but the UK has a sovereign currency and central bank. Chalk and cheese.)

Dr Belke said France is already under pressure. BNP Paribas, Société Générale, Crédit Agricole may need €20bn in fresh capital, with knock-on risk for the French state. He warned that France’s public debt (Now 82pc of GDP) would shoot up to 90pc of GDP if the debt crisis rumbles on. Variants of this theme were picked up by other German economists in a Handelsblatt
forum.

Thorsten Polleit from Barclays Capital said France’s banking woes could put "massive pressure" on French finances, but the risks do not stop there. Germany itself is at risk. "The bail-out burdens taken on by the German government could lead to a drastic deterioration of our own debt, and put Germany’s AAA in doubt."

Mr Polleit told me Germany’s debt was 83.2pc of GDP at the end of last year (higher than France, but the current deficit is much lower). "Of course there is a danger. We are in a tough situation and there is no easy way out."

We will find out soon enough what EU leaders actually intend to do – rather than what the European Commission would like them to do. As US Treasury Tim Geithner said "the devil is in the details", not in the headlines.

Chancellor Angela Merkel sought to play down the Grand Plan earlier today. "Dreams that everything will be resolved and dealt with by next Monday cannot be fulfilled," said her spokesman. There is no "big bang" miracle cure.

So far there is an ominous silence from the rating agencies. One has to wonder what they think of apparent plans to use the EFSF for "first loss" guarantees of EMU debt — debt to be upheld by states that may or may not be solvent, depending on the trajectory of the world economy and the trigger-happy reflexes of uber-hawks at the European Central Bank. At the moment the EFSF is a privileged creditor (or so we assume: this is not contractual).

Banks, life insurers, pension funds, and others who bought Greek debt in good faith will take the loss. Only once they are reduced to zero with a 100pc haircut does EFSF debt start to be written down – ie, this is "last loss". The new "first loss" idea inverts the order. The EFSF would take the first hit. That changes everything.

Surely the EFSF deserves no more that BBB rating, or perhaps just CCC, if EU leaders really embark on this course. The whole discussion has become surreal.

FredFredson · #4 (**permalink**) 24-10-11, 08:29 PM

Bank of America shifts derivatives risk onto taxpayers
San Francisco Business Times by Mark Calvey, Senior Reporter
Date: Friday, October 21, 2011, 2:48pm PDT - Last Modified: Friday, October 21, 2011, 3:08pm PDT
Bank of America shifts derivatives risk onto taxpayers - San Francisco Business Times

Mark Calvey
Senior Reporter - San Francisco Business Times
Email | Twitter: @MarkCalvey

Bank of America reportedly shifted $55 trillion of risky derivatives from its Merrill Lynch unit over to its retail bank, which holds deposits ultimately backed by U.S. taxpayers.

The move, initially reported by Bloomberg this week, moved into the full glare of the public spotlight by Friday.

The New York Post reported that the “funky Merrill Lynch derivatives” were transferred at the request of those on the other side of the derivative trade after the bank’s debt was recently downgraded.

That’s not surprising since ratings downgrades often trigger calls for more collateral from derivatives holders wanting to ensure their counterparties are good for the money if they have to pay up. With the derivatives now in the hands of the banking unit, FDIC-insured deposits can be tapped to make good on those derivatives, if necessary.

"There are many reasons trades are moved, this is common practice across the industry and done at the request of the client," said BofA spokeswoman Colleen Haggerty. "These trades do not impact FDIC insurance or insured deposits. Derivative positions are hedged and subject to robust risk-management practices and do not pose any material risks to the bank."

Those reassurances do little to allay concerns.

And it’s no surprise that the Federal Deposit Insurance Corp., which is on the hook should BofA fail, isn’t happy that the Merrill Lynch derivatives were moved into the banking unit.

The FDIC insures a large portion of BofA's deposits, especially with unlimited deposit insurance provided industrywide through the end of 2012 on deposits that don't bear interest.

While the law says the FDIC depends on the banking industry to pay for losses from failed banks, Felix Salmon notes in his Reuters blog that “it’s hard to imagine the agency could ever charge enough to cover costs from a failure at a company with $2.2 trillion of assets.”

Despite the FDIC’s reported concerns, the Fed has the final say on the derivatives transfer.

BofA (NYSE: BAC) purchased Merrill Lynch as it was heading toward failure on the same 2008 weekend that Lehman Brothers was tumbling into bankruptcy. Today, some analysts view the Merrill deal as a success for the nation’s second-largest bank. But it’s easy to make Merrill Lynch look good if the firm’s problems, including $55 trillion in derivatives, are being dumped on BofA’s retail banking unit.

Major banks’ derivatives operations, which operate largely in the shadows, continue to concern many about the vulnerability of the global financial system.

And once again, the nation’s largest banks are pocketing profits on risky derivatives with U.S. taxpayers standing by to pick up the pieces if, some say when, things blow up.

Mark Calvey covers banking and finance for the San Francisco Business Times.