Per this link.
Am I understanding this right: that the FDIC is now responsible for insuring $75 Trillion dollars worth of derivatives? It seems more complicated then that; but is this a good idea?
The FDIC doesn’t insure a bank’s assets, it insures its deposits (or depositors depending on how you look at it.)
cryptogon.com » Federal Reserve Now Backstopping $75 Trillion Of Bank Of America’s Derivatives Trades Not according to Bloomberg. The trillions was moved to make it backed by the Fed.
http://www.nakedcapitalism.com/2011/10/bank-of-america-deathwatch-moves-risky-derivatives-from-holding-company-to-taxpayer-backstopped-depositors.html\
Under bankruptcy rules, the hedge fund holders of derivatives would be first in line if Bank of America was liquidated. This move suggests that it is a definite possibility and the bank is picking winners and losers in the event it happens.
<nitpick>I should have said 53 T$, not 75 T$</nitpick>
I don’t know about the specifics of BofA but when a company is holding derivatives it usually means it has organized the bet between buyers and sellers, a bit like a bookie [Insert Trading Places reference here].
A company (A) may place a derivative bet in case currency fluctuations go against it, for example meaning borrowed $US become more expensive (the bet is basically shorting the dollar) and another company (B) which needs to bet the opposite, as it has invested its own currency in US Treasuries and will lose if the dollar rises - they are long the dollar compared to their own currency.
Now say company B didn’t need all of that exposure, so it hedges the bet by buying another derivative against Company C. Now, what if Company A decides to reduce its exposure to the derivative but Company C doesn’t want to cancel, so Company B cannot. Now Company A sets up another derivative with Company D.
And so on, ad infinitum.
Therefore, $75 trillion sounds a lot but the overall exposure to BofA is nill as it doesn’t guarantee any of these bets, and all being well they are all covered by all of the companies involved hedging and capital held. If Company H fails (and so cannot cover its liabilities) it’s up to the other companies to sort it out between themselves. AIG actually covered some of the derivatives it held - for extra commission - and this was why it needed a bailout.
In this instance ‘Company’ can mean hedge funds, pension funds, Royal/wealthy families, Bill Gates, Sovereign Wealth funds etc.
At least this is my understanding, but corrections would be more than welcome.
My guess is that it is done for the liquidity purposes. As my another guess is that they may be out of the money on those derivatives and in order to keep the balance right you need some stable and reliable funding to keep liquidity ratios afloat.
The fact that FDIC is insuring deposits only means that likelihood of a bank run off is relatively low.
$75T sounds like a notional amount of derivatives which is fine. I’m not familiar with their product mix (i.e. amount allocated to FX, Interest Rate derivatives etc.) but the devil’s in details.
Where things can get real choppy is the credit default swaps where a particular series of defaults in their underlying portfolio can cause a large outflow of cash to cover those losses.
So, having a large quantity of deposited cash acts as an internal liquidity bridge and it’s cheapest funding possible.
No, it does not suggest that at all. They key here, from BAC’s perspective, is not where the derivatives were moved TO, it is where they were moved FROM. BAC wanted the derivatives moved out of their Merrill Lynch subsidiary, as it has had negative effects on Merrill’s ratings. For BAC, the impact of having them on the deposits side doesn’t hurt them as much, so they would prefer them there.
I am not saying whether this is a good thing or a bad thing for non-BAC parties (my personal opionion right now is that it is neither, really), I’m just saying that this isn’t a sinister ploy by BAC to move assets in preparation for liquidation.
The FDIC insures bank account deposits. Most alternative, non-cash holdings (i.e. mutual funds) are not covered by the FDIC if I understand its function properly. If it turned out that all these assets held by B0A were to calf, the FDIC would be on the hook for the deposits of B0A customers’ cash bank accounts. If it is like the Canadian equivalent, there is a maximum amount per depositor that is insured.