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Is Bank of America Gambling on Resurrection (or Is BoA Holding the US Hostage)?

posted by Adam Levitin

What would you do if you were running an insolvent company? The smart thing is to bet big:  go with a high-risk/high-return strategy.  If the gamble pays off, you're solvent, and if not, well, you're already insolvent.  You're playing with the creditors' money. (And without a tort of deepening insolvency, there really isn't a clear downside for management.)  This is gambling on resurrection.  

We've seen the disastrous results of banks gambling on resurrection.  That was the S&L crisis. Rising interest rates in the late '70s decapitalized the S&Ls as the S&Ls' assets were long-term, fixed rate mortgages that paid lower rates than the S&Ls had to pay depositors.  The S&Ls, however, got a pliant Congress to agree to massive deregulation that allowed them to expand into all sorts of new business lines, like commercial real estate and race horses and junk bonds. Insolvent S&Ls went chasing high risk/high return projects.  The result was that the tab for taxpayers to fix the S&L mess was significantly greater.

Today, it looks like Bank of America is repeating the S&Ls' gamble on resurrection and using this gamble to hold the US government hostage.  

It's hard to tell if Bank of America is really insolvent--lots of assets aren't marked-to-market.  But it's telling that the market cap is around $65 billion, while the book equity is at $220 billion. The market thinks that BoA has $155 billion of bogus assets or unrecognized liabilities. If BoA isn't a zombie, it's the next thing to it.  

The smart move for BoA, then, would be to gamble on resurrection. And it seems that is exactly what BoA is doing. What's the most obvious high risk/high rewards strategy available presently? Writing CDS on European sovereign debt. Going long on Greece (or all the PIIGS). This is exactly what BoA (and other US banks) have been doing

Here's what's really scarry.  BoA just moved its derivatives business (where it does its CDS) from Merrill into its insured depository. BoA's immediate motivation might have been to reduce collateral requirements following itsSeptember ratings downgrade. But there's also a huge political benefit to the move.  Remember that CDS are qualified financial contracts that will come before FDIC claims. So it looks like BoA is gambling on resurrection at the expense of the US taxpayer. If things work out in Europe, BoA makes a bundle. And if not, the US taxpayer picks up the tab. 

This means that BoA has the US government over a barrell. BoA can basically tell Treasury that it had better make everything good in Europe or it will be paying the bill. By strapping a financial bomb to itself, BoA is in a position to dictate terms to the US government regarding international financial policy. The difficulty for BoA, however, is that the Administration understands that intervening to help the Europeans will probably cost them the election (never mind that we already did this when we bailed out AIG and protected its regulatory capital arbitrage swap counterparties).  

But here we are, a year after Dodd-Frank and three years after the financial crisis, and a too-big-to-fail bank is in a position to hold the US government hostage. If this doesn't underscore that too-big-to-fail is a threat not just to the US economy, but to the US political system, I'm not sure what does. 


The treatment of CDSs under the FDI Act (i.e., as QFCs) is the same as under the new resolution authority, so BofA's move changes nothing. BofA doesn't have the government "over a barrell" any more or less now than they did when those CDSs were in the holding company.

That's assuming, of course, that there were any CDSs at all in the derivatives that were transferred to BofA's insured depository. The Bloomberg article doesn't give any amount for the derivatives being transferred, nor does it say what kind of OTC derivatives were transferred. And it definitely doesn't say that BofA transferred its entire "derivatives business" from Merrill to BofA. That's definitely not true.

In sum, both your facts and your argument are wrong on a very basic level.

Try again.

Well, Mark S ' comment is a more valuable contribution than the arricle that it replies to.

Bank of America deserves to be scrutinized, but on sound and objective basis. Smoke and scare noises dont help. Rather, they damage.

Mark S., you claim that I'm wrong on facts and law. I beg to differ on both.

(1) Facts. I never claimed that BoA transferred its "entire" derivative business to the depositary, and the Bloomberg piece doesn't quantify the amount. But there is a clear implication that it is a substantial part of its business.

(2) Law. First, let's be clear about how narrow your criticism is. You don't have anything to say about BoA going long on European sovereign debt via CDS. That's the key point here. The shifting of derivatives to the depositary is subsidiary and, in your opinion, irrelevant. So, even if you're right, my main point still holds.

But I think you're wrong on the subsidiary point about the derivatives transfer. Yes, QFCs get the same stay exception under the FDIA and Dodd-Frank as under the Bankruptcy Code. But that's beside the point in the real world.

It's all well and good to have a theoretical right to terminate your contract and grab your collateral. But a key lesson from Lehman is that it doesn't mean that you can do so easily and even if you do you will have to liquidate that collateral at firesale prices. So it's better not to have to deal with a bankruptcy at all. How do you avoid dealing with bankruptcy? Have a counterparty that will be bailed out. That WILL happen for the BoA depositary. Merrill is more dubious, particularly in light of the Lehman precedent (query, however, whether any part of BoA can collapse without the entire entity going down). So there is real value to a counterparty in having the derivates book at the depositary. And that same value is what lets BoA hold the government over a barrel. It's a more convincing threat to say "we've strapped a bomb to BoA" than "we've strapped a bomb to Merrill". Indeed, if I'm wrong, then how do you explain the transfer of at least part of the derivatives book? What's the possible motivation?

Bottom line is that you've ascribed a strawman position to me on the facts and haven't touched my basic argument, just a non-essential subsidiary point.

"Going long on Greece (or all the PIIGS). This is exactly what BoA (and other US banks) have been doing."

Did you read the article you linked to? It makes no mention of the composition of the +$80.7 billion gross CDS exposure. For all you know it could all be taken on by GS, JPM, C... The BIS publication Bloomberg references doesn't include exposure by institution. Unless you have access to some confidential regulatory data, there's no way you can know that Bank of America has been increasing its risk profile in Europe.

Why does AIG-owned United Guaranty oppose HARP 2.0 reps and warrants waivers?

Answer: AIG-UG was (is still?) a federal contractor charged with helping to build the case for GSE put back
demands over the past few years*. They have first-hand knowledge of the dubious quality of existing 2005-2008
GSE portfolios. These are loans that have already failed or are in “imminent default.”

These are the loans that
are the object of HARP 2.0.
* per 4th document below: $550M for ’08; $650M ’09; $400M thru May ’10. “Still looking at” ’06 and ’07 loans.

AIG Resists Concessions to Banks for Obama Refinancing Plan
By Jody Shenn, Noah Buhayar and Prashant Gopal
November 15, 2011 0:01 AM EST

Housing Wire
AIG-owned United Guaranty opposes HARP 2.0 reps and warrants waivers
Tuesday, November 15th, 2011, 4:16pm

Banks Resisting Fannie, Freddie Demands to Buy Back Mortgages
By Lorraine Woellert and Clea Benson - Nov 30, 2010 12:00 AM ET

Event: Phone interview with William H. Brewster, Fannie Mae

bzhou--fair skepticism based on the reporting, but come on. Do you really think BoA is doing something totally different than its peers? If we know anything about BoA's corporate behavior over the past 20 years, it's that BoA will do whatever anyone else is doing, but do it on a larger scale and less competently. And what other explanation is there for the move in the location of the derivatives book?

Actually, in my experience and I suspect it would be echoed by most advisors to troubled companies, the people who are "running an insolvent company" that is a public company, become extremely risk averse, are hyper-concerned about being sued and take less, rather than more risk going forward. This is one example of how theory and practice completely differ. Only a handful of super-aggressive types with controlling equity stakes, who don't pay attention to their advisors anyway, like the Hunt brothers, have been exceptions to the rule.

Invariably, BOA is holding the US Hostage. BOA is own by Saudi Arabia . It's main purpose is to disrupt the US economy ,financial terrorism,and ultimately create war amongst our own people.

As a result , Occupy Wall St. Was born and these U.S MSsss organizations will create conflict between the "haves and have not" . Martial Law is next....

Thanks for this story... There is so much to talk about with BofA these days... lukily homeowners are beating them left and right in court with the right evidence from the SEC EDGR Database along with the right monthly trustee cash flow data from Bloomberg.

to Quote: "It's hard to tell if Bank of America is really insolvent--lots of assets aren't marked-to-market. But it's telling that the market cap is around $65 billion, while the book equity is at $220 billion. The market thinks that BoA has $155 billion of bogus assets or unrecognized liabilities. If BoA isn't a zombie, it's the next thing to it."


From the author's response to the comments, I must admit my doubt in the utility of this story.

The conclusion: Bank of America is taking a big risk to save itself from insolvency because total failure will be prevented by the U.S. and success will go in their pockets.

The facts behind the conclusion: Banks in general are investing in the same notes.

Although yes it's likely that B of A is engaging in the same behavior as everyone else, it's still somewhat absurd to express outrage based on an assumption.

Further, if this is a huge, hail mary risk that B of A is taking, then why are banks that are not allegedly insolvent doing the same? I think that the two assumptions: this is a huge risk and B of A is doing what everyone else is doing, contradict each other.

KS--there's two other possibilities:

(1) they're all insolvent, just to differing degrees, with BoA being perhaps the worst off.

(2) there are other reasons than doubling down to go long on European sovereign debt. BoA might be doing it because it is insolvent, while others may be doing it because the high yields are attractive to them for different reasons (like short-term compensation).

Another fair assumption is that if the BAC management is still taking decisions and plotting moves in judgment anything like the Countrywide acq. debacle, and I've seen nothing to dissuade me that they've gotten religion to run a "right ship", then it naturally follows that they'd double down on folly.

Thats what fools do. Problem is, these fools have the ability to demolish our economy and politics.


There are still multiple major problems with this theory.

Selling insurance isn't the type of bet you make when you want a large potential payoff. The payoff looks like a short put option, but step-wise. The criticism against financial insurance product sellers is that they're picking up pennies in front of a steamroller. Emphasis on pennies, because collecting premiums would be exactly the wrong type of asymmetric bet for BAC to initiate if it were truly going "all-in."

Out of the PIIGS, only Greece had a 10 year CDS yield above 7%. And before you speculate that the +$80.7 billion CDS exposure was ALL from Bank of America, all going into Greece, the total outstanding gross sovereign CDS on Greece was $78.70 billion as of January 14, 2011 and $78.13 billion as of July 2, 2011. I'd be willing to bet that Bank of America has a net exposure to the Greek government of less than $500 million.


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