Wednesday, October 19, 2011

Disturbing numbers from the OCC, radio talk host version: Run, Run, Hide!

The first domino in the next big crash appears to be leaning toward the taxpayers and it‘s a monolith of immense proportions. Bank of America that was until recently the world’s largest bank, has moved $75 trillion worth of derivatives from its Merrill Lynch division to a division with FDIC insured deposits. They did this following a downgrade of their credit rating last month. The only reason to do such a thing is to try to shift the deck chairs around to make up for the hard list the ship is having after hitting that pesky iceberg.

Reports are that the FDIC is beside itself about the risk this poses for taxpayers who would be on the hook to cover deposits should the old rust bucket head for the bottom. We wouldn’t be on the hook for anything like $75 trillion of course, only for the insured deposits. However, BoA holds 14% of all US bank deposits, how much of this would be covered isn’t clear. Nor can we guess how much damage the loss of the remaining “un-insured” deposits would do to businesses, municipalities and the like who would exceed FDIC limits. To cover all deposits would take a new act of Congress.

In a normal insured default, the bank itself would be seized, the stock holders wiped out and the management fired. BoA management has already allocated billions in bonuses, even as company hemorrhages an equal number of billions. Here’s term from contract law, “claw back” or the principle of not letting the bastards get away with the money. This wasn’t done after the last crash because the Bush Crime Family wasn’t interested. The new at the time Obama Administration couldn’t or wouldn’t do anything about it, but instead let the banks pretend to pay back the TARP money so that they were out from under government scrutiny.

The whole scam appears about to repeat itself. It’s hard to say how long this could take to play out, but if like Lehman Brothers there is a demand for payment by the counter parties of the $75 trillion in derivatives or even a small fraction of that as collateral, then BoA would cease to exist. It could happen over a single weekend the way JP Morgan ate Lehman’s lunch and they have now passed BoA to become the largest of the too big to fail banks. Coincidently the report from the Office of the Comptroller of the Currency (OCC) shows that JP Morgan currently has $79 trillion in derivatives.

Under the Dodd-Frank Act there is supposed to be an orderly wind down of these big banks when they fail, this is to be conducted by the FDIC the same as they do it with small banks. It’s questionable if they are in any position to make it work in a timely fashion as the framework under the Dodd-Frank Act for this hasn’t been completed (and it’s never been done before on such a monster, banks a fraction of this size have created panic) or even if the FDIC has enough money to pay the depositors. There are calls to simply break up BoA and not wait for it to fail, but I suspect that doomed ship sailed long ago.

As far as the FDIC being capable, the Congress did authorize a $500 B line of credit for the FDIC a couple of years ago. This may not be enough, especially if the contagion spreads to the other big four banks that account for something like 2/3 of bank assets. Who knows what the tea bag Congress might choose to do if regulators show up with their begging bowl wanting some serious pocket change. If Republicans treat the country to the sort of nonsense they put on display during the debt ceiling default crisis, they would certainly trigger a worldwide bank panic or worse.  Run, run, hide! www.prairie2.com

7 comments:

John said...

Are we to assume that the BoA's nominal $75 trillion of derivatives is the upper limit on the BoA's obligation to pay if the bets underlying the derivatives go against the BoA?

Is it the sum of payments the BoA received from the buyers of said derivatives that has been put under FDIC protection?

John Puma

Anonymous said...

Sounds like the banks and Wall Street of 1929 all over again. This time there will be know WWII to bail us our of this one.

prairie2 said...

No, the FDIC doesn't pay off derivatives, but a claim against the bank for any significant portion of them crashes the bank and then they can't pay their depositors.

John said...

To P2:

So what's keeping the rest of the total of outstanding derivatives out of FDIC institutions?

I've heard that derivative total is as high as a cool quadrillion. Is that your estimate?

John Puma

prairie2 said...

This sort of practice can be prohibited under the Dodd-Frank Act, but it sounds like the Federal Reserve is okay with it and they are part of the regulatory committee that decides what the rules are.

Anonymous said...

A friend of mine is buying BAC shares as the price drops. He realizes he is gambling, but his bet is the government won't let a bank named "Bank Of America" collapse, default or go bankrupt, as it would not look good to the rest of the world.

I realize this is a psychologically driven theory, but it kind of makes sense to me... What do you think?

prairie2 said...

Even if the bank survives, that doesn't mean the stock holders won't be wiped out. I would put the odds of success at about the same as lottery tickets.