There are some things that when first heard, sound too unbelievable to even be plausible. When I heard that Bank of America was moving $70 trillion in financial derivatives (that’s not a typo) from its investment banking division of Merrill Lynch into its commercial banking division, I thought it was an Onion article.
First of all, the entire estimated global economy for 2010 was $61.96 trillion, which means that somehow Bank of America has a few pieces of paper worth more than the entire global economy. That is in itself is hard to believe. On top of that, Bank of America had the audacity to openly flaunt a legal way it could receive a taxpayer bailout should the firm collapse and go bankrupt.
The entire scheme is a convoluted mess that hides behind complexity and a lay public to achieve its ends.
To understand how Bank of America is able to do this goes back to a little known bill called the Gramm-Leach-Bliley act passed in 1999, which was named after three Republicans who cosponsored and introduced the bill. The bill repealed prohibitions many of the provisions of the Glass-Steagall act of 1932.
For almost 66 years, banking institutions were regulated by the Glass-Steagall act, which established the FDIC insurance program and prohibited the mergers of investment banks and commercial banks. This bill was passed during the depths of the depression as a way to ensure that banks could no longer gamble with their depositor’s money on risky investments.
One of the crucial aspects of the bill was the distinction between commercial and investment banking. During the 1920s, many banks had used deposits from their commercial banking side to invest in the very lucrative stock market. Profits soared, but when the stock market crash of 1929 happened and the depression ensued, banks who had invested depositor money in stocks and other investments became insolvent overnight.
Glass-Steagall was a resounding success. For decades, markets were much more stable and enabled long periods of growth without the boom and bust cycle that had previously dominated the markets. Depositors were no longer financially ruined if banks became insolvent due to the FDIC insurance program that reimbursed depositors up to a certain amount should a bank go under.
Amid the anti-regulation fervor of the 90s, the Gramm-Leach-Bliley act repealed provisions of Glass-Steagall that barred the merger of investment banks and commercial banks. Within a few years of the bill’s passing, Citi Bank merged with Traveler’s investment group to form Citigroup, then the largest bank by total assets at the time.
In 2005, there was a significant bankruptcy reform bill that made it extremely difficult to undergo the process of bankruptcy, to the detriment of debtors.
In a little known provision in the bill, derivatives holders were given priority access to liquidated assets from entities that were undergoing bankruptcy. This was a complete break from traditional bankruptcy law which held that all creditors were the same and all received equal shares of liquidated assets.
Fast forward to 2008 when the global economy teetered on the edge of total collapse, then Treasury Secretary Hank Paulson negotiated deals for most of the commercial banks to purchase the insolvent and struggling investment banks.
Bank of America bought Merrill Lynch and J.P. Morgan Chase bought Bear Sterns. All of these deals were backed by the Federal Reserve and the U.S. government; otherwise, these deals may not have been feasible.
With these purchases, the federal government agreed to take on most of the bad debt through the troubled asset relief program or TARP and allow the big banks to gain the valuable assets. It was crony capitalism at its finest.
It is at this point that Bank of America had begun to see problems with the derivatives it inherited in its purchase of Merrill Lynch. The banks were still vulnerable to a weak economy and a dangerously low capitalization.
As a way to give the illusion that Merrill Lynch is well capitalized, Bank of America plans to move leveraged assets such as their derivatives over to the well funded commercial banking side.
This is where the Gramm-Leach-Bliley, Glass-Steagal and the Bankruptcy reform acts come together in a perfect storm to potentially leave taxpayers on the hook for trillions.
If Bank of America is successful in shifting their financial derivative assets over and should it become insolvent, derivatives holders would be the first in line to receive any money generated from the liquidation of assets.
Because of this, average depositors such as regular bank account holders could potentially receive nothing, leaving the FDIC to pick up the tab.
This would result in the FDIC having to potentially cover more than a trillion dollars in lost deposits and would make the FDIC insolvent overnight.
The further result would be a congressional vote to pay for the FDIC bailout, and because the life savings of millions of Americans is on the line, Congress would have no other choice but to fund the bailout.
It would be ingenious, if it weren’t so insidious, for Bank of America to ensure a backdoor bailout where there are private gains and public losses. There is no better reason than this to reinstall the Glass-Steagall act and break up the big banks such as Bank of America and end crony capitalism.
Alex Caraballo can be reached at acaraballo21@gmail.com