Shock Report: Federal Reserve to Backstop Bank of America's European Derivatives

Bank of America (BofA) is shifting derivatives in its Merrill investment-banking unit to its depository arm, which has access to the Fed discount window and is protected by the FDIC, reports the Daily Bail.

What does this mean?

It means that the BofA's European derivatives are now going to be “backstopped” (i.e. supported) by U.S. taxpayers. What is even more shocking is that, according to the same Daily report, Bank of America did not even seek or receive regulatory approval for this; they “just did it at the request of frightened counterparties.”

Given the dismal financial situation in the eurozone, the Fed and the FDIC are now bickering back and forth as to whether or not this is a good idea. The FDIC ("which would have to pay off depositors in the event of a bank failure") disagrees with the transfers while the Federal Reserve "has signaled that it favors moving the derivatives to give relief to the bank holding company," reports Bloomberg.

Daily Bail reports:

This is a direct transfer of risk to the taxpayer done by the bank without approval by regulators and without public input . . . JP Morgan is apparently doing the same thing with $79 trillion of notional derivatives guaranteed by the FDIC and Federal Reserve.

What this means for you is that when Europe finally implodes and banks fail, U.S. taxpayers will hold the bag for trillions in CDS insurance contracts sold by Bank of America and JP Morgan.

A CDS is a credit default swap. It’s a lot like an insurance policy in that it requires the seller of the CDS to compensate the buyer in the event of loan default. Bank of America and JP Morgan have been selling these at an almost breakneck pace.

Get that? The FDIC is now insuring trillions in CDS contracts sold by Bank of America and J.P. Morgan. Where do you think the FDIC gets the money to compensate the buyers of said CDS contracts?

The Daily report continues:

Even worse, the total exposure is unknown because Wall Street successfully lobbied during Dodd-Frank passage so that no central exchange would exist keeping track of net derivative exposure.

This is a recipe for Armageddon. Bernanke is absolutely insane. No wonder Geithner has been hopping all over Europe begging and cajoling leaders to put together a massive bailout of troubled banks.

His worst nightmare is Eurozone bank defaults leading to the collapse of the large U.S. banks who have been happily selling default insurance on European banks since the crisis began.

Some regulators are not terribly happy with the move and are currently discussing how best to protect FDIC banking operations.

“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, in a recent Bloomberg article.

“We should have fairly tight restrictions on that,” he added.

Not surprisingly, those involved in this latest move by the Feds and Bank of America are remaining quiet about the whole deal.

Jerry Dubrowski, a spokesman Bank of America, declined to give Bloomberg a comment but only said (via email) that Bank of America “continues to accommodate the needs of our clients through each of our multiple trading entities, including Bank of America NA [referring to the company’s deposit-taking unit]."

Barbara Hagenbaugh, a Fed spokeswoman, told Bloomberg that she couldn't discuss supervision of specific institutions.

Greg Hernandez, an FDIC spokesman, declined to comment.

Read the Full Bloomberg Report Here.

(H/T The Daily Bail)