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FDIC To Cover Losses On $75 Trillion Bank of America Derivative Bets

Posted on October 20, 2011 in Bank Failure, Banking News, Biggest Banking Failures, Dodd-Frank Act, Failed Banks, FDIC, featured, Mega Banks, problem banks, Too Big To Fail Banks ·

Potential losses on Bank of America’s massive $75 trillion book of risky derivative contracts has just been dumped onto the FDIC by the Federal Reserve.

Derivatives, once described by Warren Buffet as “financial weapons of mass destruction” are complex contracts entered into for speculation or to hedge risks linked to a wide variety of other (derivative) financial instruments such as currencies, commodities, interest rates, bonds, etc. In testimony to the Financial Crisis Inquiry Commission in March 2011, Buffett warned that the trillions in derivatives held by major banking institutions could be “disruptive to the whole financial system” and that the risks were “virtually unmanageable.”

Regulators have fought to rein in risky trading in derivatives by banks under the Volcker Rule, but the banks have fiercely resisted and, so far, have been winning the battle. Derivatives contributed to the financial meltdown in 2008 when the government was forced to bail out giant insurance company AIG whose huge derivative bets exploded, putting the entire financial system at risk. Part of the problem is that due to the immense complexity of derivatives, regulators are unable to formulate rules that would effectively regulate them or reduce risks.

Each derivative contract entered into by a bank has counter parties taking the opposite sides of the risk trade. If the credit worthiness of one institution holding a derivatives contract is questioned, the entire complicated interplay of counter parties could quickly morph into a systemic financial crisis. Holders of derivatives who thought they were protected from a certain risk would suddenly discover that the counter party they had expected to pay them is not able to. This would result in a cascade of derivative defaults such as happened with AIG in 2008. In order to prevent multiple collapses of major institutions, the Government was forced to step in with a massive aid package of $182 billion.

Instead of curtailing derivative trading, the major banks have expanded their risky trading. Bank of America, with a massive position of $75 trillion in gross derivatives, suddenly has a crisis on its hands. Nervous counter parties are demanding more cash collateral after downgrades of Bank of America’s credit rating. It’s 2008 all over again, nothing has changed and the risk of losses are once again being transferred to taxpayers as explained by Bloomberg.

Read More Here: http://problembanklist.com/fdic-to-cover-losses-on-trillion-bank-of-america-derivative-bets-0419/