Is the US Government Too Big To Fail?

The media has been cranking up the outrage machine since Bloomberg reported that the Fed let Bank of America get away with stuffing a load of derivatives contracts in it’s consumer banking subsidiary last week. BofA probably didn’t want to, but the reasons that it had to do it are specious at best.

The counterparties to the Merrill derivatives in question actually demanded the move because of Merrill Lynch’s downgrade by ratings agencies.  What Merrill’s counterparties were seeking was the security blanket of the Federal Deposit Insurance Corporation, the government institution that insures individual depositors for up to $250,000 per person, per bank in the event of a bank’s failure.

In a way, the FDIC performs the type of bailout that taxpayers are okay with.  Simply giving innocent, normal folks their money back when someone else screws things up for them.  Throwing risky derivatives, the things that Warren Buffett calls “financial weapons of mass destruction” into the mix understandably gets on people’s nerves.  Especially when as much as the bets that Merrill has taken amount to a possible (if not probable) loss of $75 TRILLION dollars.

One reason why even Merrill’s counterparties shouldn’t be taking any comfort in a government guarantee that their derivatives wil be honored is this little snapshot from the FDIC’s own balance sheet.










Yes.  The FDIC is in the black for the first time since 2009 and it have a whopping $3.9 billion dollars at their disposal to clean up the messes at small local banks that have

If just 3% of those derivates don’t end up in BofA’s favor, not only will the bank have zero assets left to pay back depositors, but the FDIC would also be sunk as well.

Of course, the FDIC has the right to demand more money from the Treasury if it need to rescue more banks than it can afford to with the dues paid by member banks.  What does that sound like?

People pay taxes to the Treasury, Treasury gives it to FDIC, FDIC gives it to Bank of America, Bank of America gives it to whatever investment bank it bet against.  Taxpayers—->Wall Street.  There you go.

Of course, this flies in the face of the long-standing wall between the Russian roulette-world of investment banking and the American public that the government is there to protect.  A few decades ago the Glass-Steagall Act would have stopped Bank of America from buying a hallowed Wall Street investment bank in the first place.


Comments are closed.