It’s about to happen all over again… But this time with Bank of America.
Here’s the background: Back in 2008, Bank of America bought Countrywide Financial – the utterly fraudulent mortgage pump and dump boiler room scheme headed up by Angelo Mozilo.
According to an investigation by Ambac Insurance Corp., a staggering 97% of the Countrywide mortgage loans Ambac investigated were fraudulent — made to borrowers with limited or no ability to meet their payment obligations.
Countrywide didn’t care of course, because they were moving the loans out the door as quickly as possible to Wall Street banks who sliced, diced and re-packaged them into (fraudulent) AAA rated mortgage backed securities that they then sold off to other schmucks.
Then to make matters worse, BoA was coerced by The Fed into purchasing Merrill Lynch, a $50 billion abomination of a deal that set the land speed record for disaster according to The Wall Street Journal. Soon after the deal closed on January 1, 2008, the US Treasury (e.g. taxpayers) had to step in with an additional $20 billion in Treasury support and $118 billion in additional government guarantees and loans.
Then it was discovered that Bank of America had approved the payout of billions of dollars of bonuses to Merrill employees just as the company reported a $15 billion 4th quarter loss, compounded by staggeringly high derivative and credit default swap (CDS) exposures that have left the firm on the brink of catastrophe.
A credit default swap is simply an insurance policy that a creditor purchases to insure against the risk of default of a debtor. It gets a little complicated from here, so stay with me because this is vitally important to understand in the context of what BoA and The Fed are trying to do now.
Let’s say I own some of the bonds of your company “Gentle Reader Corp”.
1) To insure against default, I buy an insurance policy, a CDS, from Merrill Lynch, typically at a price that isn’t even remotely close to reflecting the true risk that you, Gentle Reader Corp. will default on your bonds.
2) Oftentimes, the price of these CDS “insurance policies” are trifling… a 2-3% premium of the underlying bonds in many cases.
3) In other words, say I own (and have CDS insurance on) $100 million of your bonds and you default. If I had no CDS insurance, I would have lost $100 million. But since I purchased an unregulated $3 million CDS insurance policy from Merrill, they are now on the hook for the entire $100 million. Doesn’t exactly look like a winning business does it?
4) But it gets worse… The crazy thing about CDS “insurance” is that I don’t even need to own the underlying bonds in Gentle Reader Corp. to purchase CDS insurance against the risk that you will default. It’s the same as if I purchased a fire insurance policy on your house in the hope and expectation that it goes up in flames so I can collect.
So how much exposure does Merrill Lynch (and by extension it’s new owner BoA) have to CDS risk? $53,000,000,000,000. That’s $53 trillion with a T!
The counterparties to Merrill’s $53 trillion in CDS (the owners of the CDS insurance policies Merrill issued) are starting to get nervous that they will never be paid on the bets they’ve made. I use the word “bets” because remember, the owners of Merrill’s CDS don’t even need to own the underlying bonds they are insuring against. Many are simply gambling that bond issuers will default so they can colllect.
So what’s being done to calm down the owners of the $53 trillion in CDS? If you can believe this, BoA is trying to transfer the liability for
the $53 trillion some of the $53 trillion in CDS exposure from their Merrill subsidiary to their regular banking subsidiary. I say some because BoA won’t comment on the record about the amount of exposure in question.
Why is this significant? Because what BoA is essentially trying to do is pledge the $1 trillion in retail deposits it has on its books as collateral against the CDS exposure it has in its Merrill subsidiary. If just 2% of Merrill’s CDS goes bad, ALL of BoA’s depositors get wiped out.
Of course that will never happen. Why? Because BoA accounts are insured by the FDIC – the federal government. How will the federal government come up with potentially trillions of dollars that may be needed to backstop BoA’s CDS exposure? They’ll print it of course. They will simply conjur it up out of thin air.
So where does The Federal Reserve stand on this blatant criminal action by BoA? They support it! Yes, even though under Section 23A of the Federal Reserve Act, which established a firewall between a bank’s depository arm and its casino arm to prevent the casino arm (Merrill in this case) from benefiting from its federal guarantee, the rules have apparently been chucked now that BoA is in trouble.
No surprise really since it was The Fed’s idea for BoA to buy Merrill Lynch in the first place. As Turd Ferguson points out here, “of course they’re going to look the other way and stick the taxpayer with the bill.”
The bottom line is that Bank of America, with The Fed’s full support, has initiated a coup to dump billions of dollars of its losses on the American public. Where have we heard this story before?
Bank Transfer Day is scheduled for November 5th. Just sayin…