This week Bank of America moved $75 TRILLION, not billion, IN DERIVATIVES TO A FDIC INSURED ACCOUNT from their holding company.
What this simply means if Bank of America can not pay on their derivative contracts, then this debt is now the debt of the Bank of American taxpayer.
With Bank of America’s credit rating downgraded, nervous counter parties to the derivatives, meaning the people that would be profit from the derivatives, are demanding more cash collateral . This is what took Bear Stearns, AIG and Lehman down in 2008.
We have a hybrid of capitalism in the United States of America. Profits are privatized, losses are socialized. The Federal Reserve approved this move, the FDIC objected. Bank of America did not have to get regulatory approval to do this; it was done SIMPLY by the request of frightened counter parties, Wall Street Banks. Who are also – surprise! – Federal Reserve Board members. These derivatives came from Merrill Lynch when they were purchased by B of A. The counter parties have CDS (Credit Default Swap) contracts on the European debt. When Europe finally explodes, it will be the fuse for another financial tsunami, earthquake and atomic bomb blast rolled into one. The article from Bloomberg News (available here) is entitled: B of A Said to Split Regulators Over Moving Merrill Derivatives to Bank Unit.
No legislation or regulation has been passed to stop another bailout. As a result we will continue to socialize the losses of the banks. Since 2008 the too big to fail banks have gotten bigger, their borrowing and leverage bigger, and their debt astronomical. This has been accomplished by billions of dollars of lobbying, with a bought and paid for Congress and Senate. The Frank Dodd Bill was successfully lobbied against so that no central exchange would exist to keep track of net derivative exposure. Wall Street has fought regulation because it would reduce profits and, more importantly, force them to reduce leverage.
Originally, these bets were designed to hedge risk, but today the derivatives market has mushroomed into an estimated bubble of about $1.5 Quadrillion. For your information, the GDP (Gross Domestic Product) of all the economies in the world is somewhere in the neighborhood of $65 Trillion. There is no central clearing house for trade of these contracts, the exact amount remains unknown. With no regulation, we the American Taxpayers and future generations of taxpayers are now literally the Bank of American Taxpayers who socialize the losses. We do not enjoy the rewards: billions in bonuses, or 0% interest rates, or even a loan. In return we get – higher taxes, fewer services, and fewer jobs. Oh, we get to keep bailing them out too. What would they do without us?
Let me explain what derivatives are. In 2003 Warren Buffet famously called them called them “financial weapons of mass destruction”. We saw the mass destruction in 2008 when the fraudulent subprime mortgage CDS’s and CDO’s (Collateralized debt obligations) exploded. And we, as well as the entire global economy, are suffering from the effect now. Derivatives are highly volatile financial instruments used to hedge or insure risks, or for speculation. It’s a fancy word to describe a bet that has been made. They are derived from stocks, bonds, loans, currencies and commodities, or linked to specific events such as changes in the weather or interest rates. Some are unregulated and some are unsecured. My simple explanation of an CDS is: I buy fire insurance on my home. In case of fire, I can collect. Unsecured CDS’s are some speculator buying fire insurance on homes they don’t own and collects on every home that is burned.
One of the major problems with derivatives is as the risks rise, so does the cost of the insurance. That’s the way insurance works. If the derivative contracts had been properly regulated it would have been too expensive to price in the subprime risk. And so it’s quite likely the risk would not have been created in the first place if appropriate price protection had been priced in. And the banks, thanks Hank Paulson, now enjoy a 30 to 1 leverage, meaning for every $ they have on deposit they can borrow 30, at 0.25%. That’s quite a deal. And when the deal goes south, the Bank of American Taxpayers steps in. Remember profits are privatized, losses are socialized.
Read what Yves Smith at Naked Capitalism has to say: Bank of America Deathwatch: Moves Risky Derivatives from Holding Company to Taxpayer-Backstopped Depository
Here’s a little insight into how what is happening in Europe is soon going to be our problem: “Although American banks have limited their exposure to Greece, they have loaned hundreds of billions of dollars to European banks and European governments that may not be capable of paying them back.
And undoubtedly bet trillions on the same debt.
There are three key takeaways here:
- there is not enough capital on hand to cover the possible losses associated with the default of a single counterparty – JPMorgan Chase & Co. (NYSE: JPM), BNP Paribas SA (PINK: BNPQY) or the National Bank of Greece (NYSE ADR: NBG) for example – let alone multiple failures.
- That means banks with large derivatives exposure have to risk even more money to generate the incremental returns needed to cover the bets they’ve already made.
- And the fact that Wall Street believes it has the risks under control practically guarantees that it doesn’t.”
Big problem Bank of American Taxpayers –
Keeping such deals separate from FDIC-insured savings used to be a cornerstone of U.S. regulation for decades. The Federal Reserve and Federal Deposit Insurance Corp. disagreed over the transfers, which were requested by counter parties (said the people, who asked to remain anonymous because they weren’t authorized to speak publicly). With the Federal Reserve being mostly controlled by the banks that are the counter parties to the Merrill Lynch derivatives , this week’s action demonstrates that is no longer the case.
JP Morgan has almost $79 Trillion in FDIC insured derivative contracts too. That $12 Billion we gave to Goldman Sachs to make their bets whole in the first bailout ain’t nothing compared to this next round.
What are we going to do?