A Brief Note About Bank of America's Recent Actions



I posted a couple of articles on Facebook regarding a transfer of derivatives from Merrill Lynch to Bank of America, N.A. the commercial arm of the Bank of America bank holding company.  I will give a shot to explaining what happened and what it means both for Bank of America and the economy as a whole.

What happened:

At the request of counterparties (institutions that purchased derivative products such as collateralized debt obligations (CDO) and credit default swaps (CDS)), Bank of America transferred at least $53Trillion and as much as $73 Trillion worth of derivative investments from its Merrill Lynch arm (which is an investment bank that is not insured by FDIC) to Bank of America, NA (its federally insured commercial bank).  This was done with the blessing of the Federal Reserve Bank and outside of any other regulatory approval or governmental oversight.  The FDIC has reportedly objected to the transfer of these assets but the transfer has gone through nonetheless.

What this means:

My first reaction was to question the amount of the notional value of these assets.  $73 Trillion is a hell of a lot of money.  However, reading several reports including the initial Bloomberg report, these amounts are correct.

What this transfer does is it takes a whole lot of risk and places it in the hands of taxpayers.  The counterparties of these derivatives most likely were having doubts about the soundness of these securities and the solvency of Bank of America in general.  Remember, BofA's credit rating was just downgraded recently by Moody's. 

If these derivatives went bust, or BofA became insolvent (or admitted they were insolvent since they pretty much are insolvent) the counterparties would be looking at the possibility of losing their entire investment or at the very least accepting a significant haircut on the securities (accepting a significant decrease in the amount that they were due like forty cents on the dollar or some such thing).

However, the commercial bank has as much as $1 Trillion of insured deposits under its hold.  These are backed up by the FDIC.  If BofA goes under, these counterparties come first in line and the government, i.e. the taxpayers, is left paying the money.

Also, the securities that were transferred to Bank of America, N.A. are almost certainly the worst of the derivatives since there would be no other reason to look for taxpayer backup on these.  The fact that these securities are more likely to go bad, means that the risk to depositors of Bank of America has just skyrocketed.  If these derivatives go bad now, the risk is on the commercial bank, which means that rather than Merrill Lynch going under, Bank of America, N.A. goes under.

Here's the best analogy I can come up with.  I buy a bunch of Picassos from Sotheby's on credit.  Sotheby's wants their bill paid and is afraid I won't be able to pay the bill.  Therefore, I take out a trillion dollar insurance policy on my house, then transfer all of the Picassos to my house, set my house on fire, collect the insurance, pay off Sotheby's and pocket the difference.  The only difference is that if I did that, I would almost certainly go to prison for insurance fraud.  Bank of America gets the seal of approval of the Federal Reserve Bank and no doubt the Treasury.

The other upshot of this is that despite their announced $6Billion quarterly profit (due mostly to accounting and bookkeeping tricks), the chance of BofA going belly up in the near future is pretty good.  Furthermore, the fact that any insurance in this case is going to go to counterparties, the shareholders of BofA are going to get hosed. 

Last, and most importantly, the fact that the Fed and Treasury are pulling these shenanigans in this case is a clear indication that they are readying themselves for yet another huge bailout of the banking industry or a continuation of the previous bailout once the banks start failing again. This is a continuation of the standard policy of Ben Bernanke and the Federal Reserve, along with the Treasury Department of both George W. Bush and Barack Obama of Privatizing profit/benefit and Socializing losses/risk.  Almost the entire risk of Bank of America's still toxic derivative portfolio has in one move by the Fed been placed on the backs of taxpayers.

Sharpening your pitchfork yet?  I sure as hell am.