Bloomberg News reports that Bank of America (with Federal Reserve approval) put Merrill Lynch credit-default swaps into BofA’s deposit-holding arm after a credit downgrade caused counterparties to demand it put up billions more in collateral.
Got that? Probably not, so let’s put it another way: Bank of America moved risky insurance contracts to a taxpayer-insured company, ostensibly to save money. The FDIC, which would now be on the hook for losses if the derivatives collapse, is not happy, and the move raises more questions about the health of Bank of America, which has already seen its market value sliced in half this year.
Bill Black puts it this way in a Bloomberg quote:
“The concern is that there is always an enormous temptation to dump the losers on the insured institution.”
And Yves Smith says this:
So this move amounts to a direct transfer from derivatives counterparties of Merrill to the taxpayer, via the FDIC, which would have to make depositors whole after derivatives counterparties grabbed collateral.
Bob Ivry, Hugh Son, and Christine Harper report that the downgrade would have required BofA to put up more than $3.3 billion in collateral to back up the credit-default swaps it bought when it purchased Merrill Lynch in 2008. They report that JPMorgan Chase already holds virtually all of its massive derivatives portfolio in its deposit-taking arm. Has it always done that?
Meantime, The New York Times‘s Binyamin Appelbaum reports this on Twitter:
Simon Johnson, throwing bombs at Boston Fed conference, says @bobivry story “looks terrible” for Fed, asks audience if it’s true. Silence.
At base, the question here is why is Bank of America only now moving these derivatives to its depositary institution and why the Fed is willing to help it do so, despite the fact that its own rules are designed to prevent it.
Smith and Black say that this move smacks of “desperation” on the part of Bank of America. If so, it does for the Fed too, which Bloomberg says wants “to give relief to the bank holding company.”
Good work by Bloomberg here keeping an eye out for taxpayers.
Ryan Chittum is a former Wall Street Journal reporter, and deputy editor of The Audit, CJR’s business section. If you see notable business journalism, give him a heads-up at rc2538@columbia.edu. Follow him on Twitter at @ryanchittum.