FDIC To Cover Losses On $75 Trillion Bank of America Derivative Bets

Potential losses on Bank of America’s massive $75 trillion book of risky derivative contracts has just been dumped onto the FDIC by the Federal Reserve.

Derivatives, once described by Warren Buffet as “financial weapons of mass destruction” are complex contracts entered into for speculation or to hedge risks linked to a wide variety of other (derivative) financial instruments such as currencies, commodities, interest rates, bonds, etc.  In testimony to the Financial Crisis Inquiry Commission in March 2011, Buffett warned that the trillions in derivatives held by major banking institutions could be “disruptive to the whole financial system” and that the risks were “virtually unmanageable.”

Regulators have fought to rein in risky trading in derivatives by banks under the Volcker Rule, but the banks have fiercely resisted and, so far, have been winning the battle.  Derivatives contributed to the financial meltdown in 2008 when the government was forced to bail out giant insurance company AIG whose huge derivative bets exploded, putting the entire financial system at risk.  Part of the problem is that due to the immense complexity of derivatives, regulators are unable to formulate rules that would effectively regulate them or reduce risks.

Each derivative contract entered into by a bank has counter parties taking the opposite sides of the risk trade.  If the credit worthiness of one institution holding a derivatives contract is questioned, the entire complicated interplay of counter parties could quickly morph into a systemic financial crisis.  Holders of derivatives who thought they were protected from a certain risk would suddenly discover that the counter party they had expected to pay them is not able to.  This would result in a cascade of derivative defaults such as happened with AIG in 2008.  In order to prevent multiple collapses of major institutions, the Government was forced to step in with a massive aid package of $182 billion.


Bank of America Sliding Into The Abyss - Courtesy stockcharts.com



Instead of curtailing derivative trading, the major banks have expanded their risky trading.  Bank of America, with a massive position of $75 trillion in gross derivatives, suddenly has a crisis on its hands. Nervous counter parties are demanding more cash collateral after downgrades of Bank of America’s credit rating.   It’s 2008 all over again, nothing has changed and the risk of losses are once again being transferred to taxpayers as explained by Bloomberg.

Bank of America Corp. (BAC), hit by a credit downgrade last month, has moved derivatives from its Merrill Lynch unit to a subsidiary flush with insured deposits, according to people with direct knowledge of the situation.

The Federal Reserve and Federal Deposit Insurance Corp. disagree over the transfers, which are being requested by counterparties, said the people, who asked to remain anonymous because they weren’t authorized to speak publicly. The Fed has signaled that it favors moving the derivatives to give relief to the bank holding company, while the FDIC, which would have to pay off depositors in the event of a bank failure, is objecting, said the people. The bank doesn’t believe regulatory approval is needed, said people with knowledge of its position.

Three years after taxpayers rescued some of the biggest U.S. lenders, regulators are grappling with how to protect FDIC- insured bank accounts from risks generated by investment-banking operations. Bank of America, which got a $45 billion bailout during the financial crisis, had $1.04 trillion in deposits as of midyear, ranking it second among U.S. firms.

“The concern is that there is always an enormous temptation to dump the losers on the insured institution,” said William Black, professor of economics and law at the University of Missouri-Kansas City and a former bank regulator. “We should have fairly tight restrictions on that.”

Moody’s Investors Service downgraded Bank of America’s long-term credit ratings Sept. 21, cutting both the holding company and the retail bank two notches apiece. The holding company fell to Baa1, the third-lowest investment-grade rank, from A2, while the retail bank declined to A2 from Aa3.

The Moody’s downgrade spurred some of Merrill’s partners to ask that contracts be moved to the retail unit, which has a higher credit rating, according to people familiar with the transactions. Transferring derivatives also can help the parent company minimize the collateral it must post on contracts and the potential costs to terminate trades after Moody’s decision, said a person familiar with the matter.

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.

That compares with JPMorgan’s deposit-taking entity, JPMorgan Chase Bank NA, which contained 99 percent of the New York-based firm’s $79 trillion of notional derivatives, the OCC data show.

Moving derivatives contracts between units of a bank holding company is limited under Section 23A of the Federal Reserve Act, which is designed to prevent a lender’s affiliates from benefiting from its federal subsidy and to protect the bank from excessive risk originating at the non-bank affiliate, said Saule T. Omarova, a law professor at the University of North Carolina at Chapel Hill School of Law.

The Fed’s approval to move derivatives from Bank of America’s holding company to the depository unit directly puts the U.S. taxpayers on the hook.   The FDIC cannot handle any large banking failure with its depleted Deposit Insurance Fund and would have to immediately tap its line of credit with the U.S. Treasury.

The Dodd-Frank attempt to end “To Big To Fail” by giving the FDIC resolution authority has been a failure.  In another crisis, the FDIC does not have the resources to absorb potentially huge losses from Bank of America’s derivative bets.  Furthermore, without massive government guarantees, there would be no buyer for a failed Bank of America given the open ended risks involved.  To prevent complete panic by the public from a looming failure of Bank of America, the Fed, FDIC and US Treasury would again have to provide virtually unlimited financial support, courtesy of the U.S. taxpayer.



  1. THIS IS WHY WE PASSED THE GLASS-SIEGEL ACT BACK IN THE !930″s. God help us save this country from the greedy banks and the politicians who want to destroy America. This may be the final nail in the coffin!

  2. Of course I meant Glass-Steagall Act. Duh!

  3. This is getting rediculous, OWS needs to see this, maybe then they would know that the real threat to america is no on wallstreet but insted resides at 2000 L Street Northwest
    Washington D.C., DC 20006, the federal reserve.

  4. Did I miss something. Like the THE PERSONS NAME WHO WROTE THIS!
    Guess not, just another someone. But hey its on the Internets so it has to be true.

    -may as well be one too.

  5. It’s business as usual in the United States. There is a conflict of interest here, the Federal Reserve board members are mostly employed by the too big to fail banks that are counter parties to the $79 Trillion in derivative contracts. The same thing as in 2008.

  6. Quote:
    Anonymous says: October 21, 2011 at 9:45 pm Did I miss something. Like the THE PERSONS NAME WHO WROTE THIS! Guess not, just another someone. But hey its on the Internets so it has to be true.anonymous, -may as well be one too.

    Do your homework before making snide remarks and looking stupid. “…like the (sic) THE PERSONS (sic) NAME WHO WROTE THIS!” —


    “Authors for Problem Bank List
    Problem Bank List provides news and reporting on the status of the FDIC’s Problem Bank List and information on troubled and failed banks. The site is edited and written by Bill Zielinski with other contributing writers. Our coverage attempts to bring light to the ongoing problems in the financial system and scrutiny to regulatory and legislative measures.
    Editor and Writer:
    Bill Zielinski
    Contributing Writers:
    Michael Zielinski
    Craig Stahl
    Problem Bank List Staff
    Contact Information:
    Problem Bank List”

  7. $75 trillion, I think not. That’s about 25 years worth of taxes, all the taxes, ergo someone left out a decimal point somewhere. $75 billion perhaps?

  8. Problem Bank List Staff says

    Yes, the number is an astonishing $75 trillion of gross derivatives, and this is just what Bank of America has. The other mega banks have equally astronomical numbers. You can see the numbers on the Comptroller of the Currency reports.

  9. Robin from Orlando says

    If BOFA fails, we the taxpayers will have to borrow another 75 trillion to bail them out. Makes our current debt look like petty cash.

    I say banks that use deposits as collateral for derivatives should lose their FDIC insurance.

  10. fact checker says

    maybe anonymous should try going to Bloomberg and reading the original article before sounding like a right wing flake and claiming this article is fake. Duh
    I suppose Anonymous couldn’t spell their own name so they didn’t use one.

  11. It makes me sick that I mail these assholes a fat check for my mortgage every month.

  12. This is rubbish. The notational value of the annual GDP of the entire planet, over 200 countries, is barely $60 Trillion dollars. There is no way this story angle makes any sense.

  13. Problem Bank List Staff says

    Yes, of course, Harry. Most people are totally unaware, uninformed and ignorant of the amount of largely speculative derivatives tradings taking place, mainly by banks, world wide. This from Wikepedia:

    Derivatives typically have a large notional value. As such, there is the danger that their use could result in losses that the investor would be unable to compensate for. The possibility that this could lead to a chain reaction ensuing in an economic crisis, has been pointed out by famed investor Warren Buffett in Berkshire Hathaway’s 2002 annual report. Buffett called them ‘financial weapons of mass destruction.’ The problem with derivatives is that they control an increasingly larger notional amount of assets and this may lead to distortions in the real capital and equities markets. Investors begin to look at the derivatives markets to make a decision to buy or sell securities and so what was originally meant to be a market to transfer risk now becomes a leading indicator.

    $684 Trillion In OTC Derivatives
    OTC derivatives are contracts that are traded (and privately negotiated) directly between two parties, without going through an exchange or other intermediary.
    Reporting of OTC amounts are difficult because trades can occur in private, without activity being visible on any exchange. According to the Bank for International Settlements, the total outstanding notional amount is US$684 trillion (as of June 2008).[14] Of this total notional amount, 67% are interest rate contracts, 8% are credit default swaps (CDS), 9% are foreign exchange contracts, 2% are commodity contracts, 1% are equity contracts, and 12% are other. Because OTC derivatives are not traded on an exchange, there is no central counter-party. Therefore, they are subject to counter-party risk, like an ordinary contract, since each counter-party relies on the other to perform.

    Exchange Traded Derivatives (ETD)

    (ETD) are those derivatives instruments that are traded via specialized derivatives exchanges or other exchanges. A derivatives exchange is a market where individuals trade standardized contracts that have been defined by the exchange’
    According to BIS, the combined turnover in the world’s derivatives exchanges totaled USD 344 trillion during Q4 2005.

    Derivatives can be used to acquire risk, rather than to insure or hedge against risk. Thus, some individuals and institutions will enter into a derivative contract to speculate on the value of the underlying asset, betting that the party seeking insurance will be wrong about the future value of the underlying asset. Speculators look to buy an asset in the future at a low price according to a derivative contract when the future market price is high, or to sell an asset in the future at a high price according to a derivative contract when the future market price is low.

    The use of derivatives can result in large losses because of the use of leverage, or borrowing. Derivatives allow investors to earn large returns from small movements in the underlying asset’s price. However, investors could lose large amounts if the price of the underlying moves against them significantly.

    Derivatives typically have a large notional value. As such, there is the danger that their use could result in losses that the investor would be unable to compensate for. The possibility that this could lead to a chain reaction ensuing in an economic crisis, has been pointed out by famed investor Warren Buffett in Berkshire Hathaway’s 2002 annual report. Buffett called them ‘financial weapons of mass destruction.’ The problem with derivatives is that they control an increasingly larger notional amount of assets and this may lead to distortions in the real capital and equities markets. Investors begin to look at the derivatives markets to make a decision to buy or sell securities and so what was originally meant to be a market to transfer risk now becomes a leading indicator.

  14. @ Problem Bank List Staff
    I personally appreciated your informative comment above – the more we all learn about these things, and express our disapproval via our votes, the less these hucksters will be able to defraud We The People!

  15. Michael Pedersen says


  16. Problem Bank List Staff says

    Thank you!

  17. Since Warren Buffett’s warning on the risk of derivatives has been bandied about, why did he invest $5 billion, with warrants to buy 700 million shares of Bank of America, back in August?

  18. There should be constructed in every town square a guillotine. They will only need to be used a few times.

  19. Problem Bank List Staff says

    Good question. Buffett buys into institutions that he thinks will survive when panic selling drops prices to levels that he considers to be a bargain. This worked out well when he invested in Goldman Sachs during the financial meltdown of 2008. Buffett obviously believes that Bank of America will survive or that they will be bailed as occurred in 2008. Bank of America is a systemically important financial institution and the government will not allow them to fail.

  20. You hit the nail on the head regarding Buffett. He probably has very little risk since the Fed will pick up the tab on BofA’s horrible management.

  21. Yep, it’s the Federal Reserve bank that is the “Weapon of mass Destruction”. President John F. Kennedy tried to put the Fed into extinction back in the spring of 1963 by signing executive Order 11110. The order called for an end of allowing the Federal Reserve Bank from printing and issuing American Currency and replacing their currency with Congress approved United States Notes backed by silver in the US Treasury…real assets not imaginary non existent assets of the Fed. They printed almost 4 billion dollars worth of these bills in denominations of 2’s and 5’s with the order to print denominations of 20’s and 50’s to follow. But in the fall of 1963 someone put a bullet in that man’s head and the plan came to a screeching halt.. LBJ didn’t see that the E.O 11110 was implemented nor has any president since. It is still on the books and is still the law… Only congress can authorize the printing of American currency according to the Constitution..period the end. If that were the case now we not not have A NATIONAL DEBT OF OVER 14 TRILLION DOLLARS. We would have zero National Debt.THE FED PRINTS OUR MONEY THEN CHARGES US “THE TAXPAYERS” INTEREST ON OUR MONEY WHICH IS THE NATIONAL DEBT.

  22. Dennis in MI says

    So BofA’s big decision to not charge $5 per month for a customers use of their debit card isn’t as big a win as the MSM is reporting. That amounts to 60$ per year for a subset of their cutomers. 75 TRILLION , liability placed upon the taxpayers is what? @ $500,000 $ per person??

    The MSM is a propaganda tool of the 1% and the one headed two party elites. Occupy the Press too!

  23. Ok can someone tell me were or how BOA will get this bailout? Were will they get the money? China? Cmon.

  24. Karen Brown says

    Actually, reinstating banking regulations, including the Volcker rule and Glass-Steagall is a position MANY in OWS agree with. If you look at the pattern of bank failure and panic in this country, and the history of regulation and de-regulation, there is a direct relationship. The more regulation, the less failure, and vice versa. The highest rates were in the late 1800’s, which led to the Federal Reserve, the late 20’s, of course, which led to the FDIC and Glass-Steagall. Then there’s this odd lull. There’s always a few here or there, but nothing major until….It starts up again with Reagan and his immediate loosening of a variety of banking rules, like number of branches, etc, and the bank failures, the S&L scandal, and the really disturbing merging of both investment and commercial banks, involvement of banks in insurance, and bank mergers, leading to the ‘too big’ of ‘too big to fail’, and only finally culminating in the full repeal of Glass-Steagall. Banks prove, over and over again, every time there’s the least leeway, that they can’t HANDLE it, and if they were the only one affected, that’d be one thing, but between the need for credit and security for deposits, their enormous impact on the stock market, we end up bailing them out. (The latest round is just that, only the latest round, there were many…..less public ones in the past.)

    We need to bring back ALL those regulations, and do a full audit and shakedown of the Federal Reserve, getting board of director members FROM those banks off the board.

  25. Karen Brown says

    And, one of two options. If banks have to be that big (or certain banks, to do functions they can’t do any other way), then treat those banks like utilities. They are even MORE heavily watched and regulated. Too big to fail, and have to continue to be too big, then NO RISKY BEHAVIOR. You don’t take your rent money to Vegas. If they don’t have to be as big as they are, then bust them up like they did for Ma Bell.

  26. Matthew Gore says

    so so true @ Karen Brown

  27. Your’e going quite good job! keep it going

  28. Great responses! The Non Agency derivatives including Synthetic CDOs that allow non-Registered events to multiply rapidly are worrisome. There is no question that all proprietary trading should be immediately separated from Consumer banking and the massive Consumer fund base that allows 40-1 leverage ratios. The Federal Reserve has for the first time, I believe, has become a hedge Fund! and a Ponzi-like scheme. We issue Debt and immediately buy it back. Have we ever done that before under any other fed Chief?

    Sandy Weill is a guy who built two Empires and believed in combing the banks. Now he’s rationally changed his mind. Jamie Dimon, who really is one of the very top management talents, found that even he had an inability to control Derivative valuation econometrically in order to synthetically hedge those values. If Jamie, who has ego to match his brains, can’t get it done and worse has to admit it. I would doubt any other head of the major banks could do it either.

    Instead they will cheat! BofA, not the equal of JPM in leadership, made the move to blame and charge the Tax Payer given default. That alone speaks volumes in whether to move the Consumer accounts out of these consortium’s immediately!

    Why are we even discussing any other path

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