Tuesday, October 18, 2011

Financial Vaporware: BOA's Sleight of Hand

Bank of America moved risky derivatives to a federally insured banking unit within the company, according to Bloomberg.  The Federal Reserve Bank of New York is in favor of the move, while the FDIC objects.

The Federal Reserve and Federal Deposit Insurance Corp. disagree over the transfers, which are being requested by counterparties.

Requested by counterparties?  They're the "investors" (gamblers) who took the other side of BOA's derivatives bet.  

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. 
Lehman Brothers failed due to bad derivatives bets and the evaporation of short term credit used to finance its balance sheet.  Nobody trusted Lehman to pay its debts or its bets.

The Fed is trying to prevent another Lehman.  While far from Lehman crash levels, credit default swaps sit at:

Merrill Lynch - 431 basis points (down from 513)
Morgan Stanley - 418
Bank of America - 380
Goldman Sachs - 360

A basis point equals $1,000 annually on a contract protecting $10 million of debt.
Moving credit and other derivatives to a federally insured banking unit, shifts risks to the FDIC.

(Thanks to Economic Policy Journal)