This Bank Of America Nonsense

Oct.19.11 | About: Bank of (BAC)

This is precisely the sort of arbitrage that ought to lead people straight to a nice date with Bubba:

Bank of America Corp. (NYSE: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.

So let's see what we have here.

Bank customer initiates a swap position with Bank. In doing so they intentionally accept the credit risk of the institution they trade with.

Later they get antsy about perhaps not getting paid. Bank then shifts that risk to a place where people who deposited their money and had no part of this transaction wind up backstopping it.

This effectively makes the depositor the "guarantor" of the swap ex-post-facto.

That the regulators are allowing this is an outrage.

If you're a Bank of America customer and continue to be one you deserve whatever you get down the line, whether it comes in the form of higher fees and costs assessed upon you or something worse.

Incidentally, the amount of exposure in question is unknown but Bank of America has some $53 trillion in total derivative exposure (out of $75 trillion in total between it and Merrill, which is also a subsidiary of the holding company.)

Of course we do not know how much was shifted and BAC won't comment on the record -- but this sort of movement of liabilities should be flatly prohibited as the counterparty in question accepted the risk of the entity they traded with originally when the transaction was first initiated. That the firm's ratings have deteriorated and thus it may be required to post additional capital against these positions by those counterparties does not justify shifting the risk to depositors simply so the bank can avoid posting collateral against a deteriorating credit picture, which for all intents and purposes shifts the risk to the taxpayer since the FDIC has a line of credit at Treasury. Never mind that posting that collateral should not materially impair operations.

After all the firm does have an excellent capital ratio. Why, they said so just this morning!

I can think of a handful of rather bemusing (and some not-very-funny) possibilities along the line of "speck into a snowball" issues that may arise in time on this deal, but for now I'll sit with a wry smile and see what develops since at this point I have nothing to go on other than conjecture. Feel free to speculate yourself in the comment section if you'd like... after all that's exactly what Bank of America openly invited when they refused to document exactly what was moved, in what amounts, what the actual net exposure is and why the step was taken.

We need to rename Bank of America DAFFY DUCK.