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Bank of America's Backdoor TARP But there's a much larger situation unfolding at the moment with the slow implosion of Bank of America and it has to do with the VERY Shaky Derivative Complex. You know...those pesky "Weapons of Mass Financial Destruction" that Warren Buffett likes to play with these days. As of the last US Office of the Comptroller of the Currency release for the first quarter of 2011 Bank of America was participating in DERIVATIVES with a notional value of...
$52,504,829,000,000 ?
OCCs Quarterly Report on Bank Trading and Derivatives Activities First Quarter 2011 Executive Summary
U.S. commercial banks reported trading revenues of $7.4 billion in the first quarter, 10% lower than $8.3 billion in the first quarter of 2010. Trading revenues in the first quarter of 2011 were 113% higher than in the fourth quarter of 2010. Trading risk exposure, as measured by value-at-risk (VaR), has declined for each of the five major dealers on a year-over-year basis. Aggregate average VaR at these banking companies has fallen 21%, from $852 million in the fourth quarter of 2010, to $677 million. Credit exposure from derivatives decreased in the first quarter. Net current credit exposure fell 6% or $23 billion from the fourth quarter of 2010, to $353 billion. The notional value of derivatives held by U.S. commercial banks increased $12.8 trillion, or 5.5%, from the fourth quarter of 2010 to $244 trillion. The notional value of derivatives is 12.7% higher than a year ago. Derivative contracts remain concentrated in interest rate products, which comprise 82% of total derivative notional values. Credit derivatives, which represent 6.1% of total derivatives notionals, increased 5.3% to $14.9 trillion.
That means they were on one side or the other of a "side bet" totaling over $52 Trillion. Win or lose that's A LOT of money to play with for a bank with total assets of only $1.4T and a market cap of $62B. I would say that Bank of America would fall into that "catch all" category of so many banks these days..."Too big to fail...but too big to save!" I'm not saying that this $52T in derivatives will all fail but if only a small portion of them do (lets' say 1% or $520B) it will set off Buffett's chain reaction much like a NUCLEAR REACTION! For those who don't think the Good Guys have the power to take down the entire Global Financial System I, uncharacteristically, would have to agree with you...but it looks like they won't have to: THE BAD GUYS ARE DOING IT FOR US!!!
In short, purchasing these servicing rights was another Troubled Asset Relief Program. Servicing defaulted loans can be good business if cheaply produced foreclosure paperwork isn't questioned, and if the foreclosures have equity and can be resold easily with lots of junk fees. But the mortgage servicing rights Fannie Mae bought are stinkers: they have a 13% delinquency rate, which means lots of foreclosures and loan modifications. Both foreclosures and mods have been big headaches for BofA, which faces potential liability for document fraud in its foreclosures on multiple fronts. Beyond that, foreclosures are simply expensive to do well. BofA was recently punished by Treasury for failing to do modifications well, and it's also been sued for how it does them. But the loans Fannie Mae now has to deal with are even worse than 13% delinquency rate suggests. According to the WSJ, "more than half of the loans are in troubled U.S. real-estate markets." This likely means markets where a high percentage of the houses are underwater and there's a huge oversupply, driving prices down further and making defaults more likely. Fannie Mae is purchasing "the servicing rights in order to transfer the day-to-day management of those loans to a different company." That's another huge sign that Fannie Mae is overpaying. If the rights were really worth $500 million, wouldn't a private company pay that for them? Instead, it sounds like Fannie Mae is doing a bailout two-step, one to BofA and one to whomever takes these rights off Fannie Mae's hands. Another thing needs to become clear: where did Fannie Mae get the money to do BofA the favor of buying these rights? Fannie Mae just asked for another bailout of its own, seeking a new $5.1 billion infusion last week. Think about how good this deal is for BofA: it gets to stop the bleeding, or at least cauterize much of the wound in its balance sheet that lousy mortgage servicing rights and mortgage securities liabilities are creating. And it gets half a billion dollars to boot. And taxpayers? Well, we get to own yet another good chunk of BofA's mess